Tuesday, 23 February 2010

Company Focus – Renault-Nissan – 'Le Cost Cutter' Returns, Awaiting an Indian Summer.

Stock Price (Paris @ 23.02.2010, 16.50 GMT)

Ordinary : Euro 30.43

In conclusion to the overview of the 'Western 8' automakers, Renault is put under the spotlight, having announced its FY09 results on 12.02.2010.

Renault-Nissan was instigated by Carlos Ghosn in 1999, to effectively create a 21st century auto-manufacturing model which had both global breadth across markets and segmentational depth within these markets. An entity that had mutual synergies & compliments, an entity which operating with “twin-pillars” could maximise the advantages of cross-shared ownership and so dual determination without the political and operational problems of fully fledged integration.

Mutual platform & systems rationality was of course the primary driver, which along with the integration of Samsung Motor, assisted in the initial years a dramatic cut in development costs and economies of scale which enabled greater production flexibility and critically cost-leverage over a broad basket of EU, Japanese, Asian and South American suppliers, all intent on 'coat-tail growth'.

The productivity improvement of platform sharing (Renault-derived on B & C segment, Nissan-derived on D, E & 4x4, Samsung-derived on niche) undoubtedly assisted on cost-savings, a level of intra-corporate competition intentionally created by Ghosn in the search for efficiency, but also pragmatically sharing best practice and learning across the empire. All though was not initially rosy, as Nissan was forced to adopt Renault sourced systems on small cars, the quality gap between the 2 marques became evident, Nissan's reputation suffering at the customer level with more 'things gone wrong' whilst under warranty, which cost national sales companies and Nissan HQ new parts costs, dealer-fit charges and internal demands that its parent Renault design to a quality standard not a cost standard.

The difference was wholly evident in earlier generation product comparisons too. Though Nissan had had good quality, its general cosmetic appeal had been lost through successive spirals of conservatism – itself driven largely by the contracting and so conservative Japanese domestic market in the 1990s and a loss of direction in the US. In direct contrast though, Renault had been able to overcome its almost endemic sub-par general quality standards by focusing upon the 3 critical customer deal-winners of the time: aesthetics, safety and credit. That focus on differential styling, NCAP test star ratings (tending to BIC) and easy access credit, firstly turned around the UK and German consumer's perceptions of Renault (even if only relatively superficial) and secondly attracted more people (of varying credit status it must be said) to drive away.

But of course Renault's claim to fame throughout the 2000s was its re-generation of Romania's Dacia as perhaps the core CEE brand, with commercial reach into selected western Europe countries and into the 'Near East'. The Logan in its variant forms and Sandero now account for nearly 257,000+ units pa in 2008.

[NB. though the dramatic CEE downturn will have significantly cut that number. Unfortunately although an inexpensive option for W.Euro buyers, the cars' mass, size and use of less advanced technology means that the loss of CEE Dacia sales have in all probability only been slightly off-set by western buyers given that it is not a 'scrappage scheme' contender. However Renault was well placed with its own cars in A & B segments].

That was the 1999-2007 success story, but of course as with its mass-market peers, Renault has been heavily hit by the consumer fall-out effect of the economic crisis, so reliant upon the French government's Euro3bn soft loan, and the demand-driver effect of EU nation-state scrappage schemes through 2009 and variously into 2010.

A paper based critique of annual and monthly YoY figures gives theoretical hope, market TIVs - thanks to incentives - showing a weak upward trend. However, the fact that so much government liquidity has been pumped into the EU and US car markets to seemingly stabalise consumption does engender the argument that once removed the downward effect may well continue, and data highlighting that approximately 50% recent sales have simply been pull-forward or indeed the opportunity jumped upon by opportunist (less scrupulous) buyers.

As highlighted in the FY09 presentation, Renault has been a visible beneficiary, its sales for the most 'flat' (hovering at a median average of 0.5%) across most of its international markets. However, the UK, Brazil, Turkey and Iran do show full-year slight losses, though for the UL and Turkey turning positive with H2 YoY comparisons. Thus as the year ended it was only Brazil and Iran in the red, and respectively only by 0.1% and 2.0% (Renault Iran consisting of just Tondar [Dacia] sedan & 'old' Megane). On a sales basis the company out-performed its peers as a beneficiary of the EU scrappage boost. The A-segment TIV increased 29%, whilst Renault gained 34%, whilst the B-segment rose 8% and Renault gained 12%. In the C-segment, whilst the TIV dropped -6%, its new Megane gained 15%. As a small-impact comparison that other segments (D/E) dropped -14%, whilst it lost -34%. However, as the EU's #1 LCV manufacturer it managed to beat heavy YoY segment losses of -30%, with a -24% loss.

As with all enterprises in the current climate, the company has been keen to demonstrate its recognised importance of liquidity and working capital.

Thus highlighted its H109 & H209 efforts respectively focused on initially securing delayed transactions to creditors (accounts payables) [giving +E486m] and latterly securing timetabled transactions from debtors (accounts receivables) [giving +E640m] (The use of any 'factoring' used, if any, was not given). Added to this was 'liquidation' of inventory stock [giving +E1,372m], plus further savings +E425m, thus proving a “WCR” contribution of E2,923m (approximately E3bn).

[NB it will not go unnoticed by many that this is of the same magnitude as France's 'soft-loan' to Renault].

Alongside the liquidity issue, is that of driven cost-savings given the loss of revenues. Carlos Ghosn having gained his nick-name as 'Le Cost Cutter' back in the late 90s, has a decade later, been required to once again lead that task with COO Patrick Pelata, and together they have had to be seen beating the income slide at fixed and variable levels. At a fixed level, 2009 was compared with 2007 and 2008 datum points, highlighting that the majority of fixed cost reduction for G&A and Manufacturing was extracted in 2008, whilst 2009 saw more punitive extractions across R&D, Net CapEx and Marketing.

Given the typical massive guzzle of the auto-industry's capital expenditure, such hard times are calling for a modified approach relating to core products and plant. With this approach Renault sizeably cut Net CapEx and the capitalised and expensed portions of R&D, leaving it -33% down compared to peak 2007 figures ('09: E3,108m vs '08: E4,342m vs '07: E4,631m). In contrast, G&A is down -20% over these 3 years.

Given the alternative annual focus on fixed-cost plant (hardware [2009]) versus people (software [2008]), it appears that a new cost-initiative may need to be made in G&A & Marketing in 2010, with moreover more efforts regards variable costs in these arenas as well as of course across production sites. Exact detail about how Ghosn/Pelata 'play' these initiatives to show YoY cost-savings (ie hardware vs software, and fixed vs variables) would be of great interest to the analyst community, though may of course be showing Renault's 'hand', beyond the cost-reduction determinant presented for variable costs.

YoY revenues were down approximately 11% (E33,712m) compared to 2008 restated figures (E37,791m). The critical operating margin fell from 0.9% (E326m) to -1.2% (E-396m) so down YoY by -2.1%. 'Other' operating income and expenses fell from E-443m to E-559m.
Net financial income and expenses down from E441 to a negative E-404m, so dropping E-845m.
'Associated Companies' fell from E437m to a negative E-1,561, so dropping E-1,998m (ie nearly E2bn). (This included Nissan E-902m – though pulling back well in Q3/Q4, Volvo Truck E-301m, Avtovaz E-370m, Other E12m).
Including current and deferred taxes (these staying relatively flat) and the Net Income for 2009 dropped from E599m previously to a negative E-3,068m, so down E-3,667m. Looking at Debt, FCF and Liquidity Reserves, debt levels have reduced YoY from E7,944m to E5,921m, cashflow now sits at 2,088m, and Liquidity (cash & commercial credit lines) has improved from E4.8bn to E9.5bn. Of the Debt, E1.1bn is payable in 2010, decelerating until 2013 when E1.4bn matures, but the real hit comes in 2014, when E4.1bn matures, the Government's E3bn, plus E1.1bn.

Renault's global market TIV outlook expects 2010 to show a -10% decline in Europe, -10% in EuroMed (Balkans, Turkey, NW Africa), “Stability” in S.America & Asia/Africa, and +10% increase in EuroAsia (Russia & ex-CIS states).

Renault states that even though 2010 will be tough it will show +FCF through 2010 due to:
1. “A gain of EU market share in declining TIV”
2. “Extraction of alliance synergies”
3. “Taking cost savings further”
4. “Sustaining a high level of WCR efficiency”

Of these investment-auto-motives believes:

1. “A gain of EU market share in declining TIV”
Renault will probably follow the typical French norm of within the matured EU of “buying market-share” (akin to PSA behavior) via maintained (or even expanded) capacity of plants - given nominal inventory depletion. The group's captured-finance house RCI able to play a key role in doing so given its stated good performance in 2009 and implicit backing from the French wholesale finance sector.
However, the strong product momentum Ghosn mentions, whilst on paper looks 'interesting' with cabrios like Megane and new Wind, will very probably suffer when put up to hard scrutiny...unless Ghosn has immediate suprises in store; which looks doubtful.
Twingo & Clio experienced sales boosts thanks to the scrappage scheme, but their innate conservative look, does little to separate them from the field, with new generation face-lifts adding little product appeal, hence the aforementioned Renault pricing power plays expected. Megane has performed and will sustain sales due to its point in its lifecycle, though without detail of internal forecasts business model expectation are hard to judge. The large cars will struggle as they have historically done. Critically, Renault has arguably over-filled the A-C segment with variants, many of which appear heavily overlapping in practical terms, even if not on paper, the plethora of MPV & 'Grand' (extended wheelbase) variants now either encroached by taller standard cars, or encroaching upon larger siblings. Thus, as with other makers desperate to fill niches, a level of product redundancy appears apparent as seen with the customer reaction to Modus, possibly repeated on a mooted Clio-Scenic (unless it proves the natural dimensional successor to Megane Scenic Mk1).

Planners have been desperate to create volume off of singular platforms to drive theoretical economies of scale, yet if production volumes do not actually meet market demand for forecast volumes, and product must must discounted on the dealer-floor then the validity of the planning exercise has been futile and ultimately for the investor, value destroying.

[NB the case of the “tail wagging the dog” has been proven all too real throughout auto-industry history, as the economic requirement for volume becomes the determinant corporate driver, not the attuned understanding of the marketplace true demand type and levels. Instead, as we see with French industry and previously US industry, volumes simply increase a manufacturer's in-market pricing power].

On the LCV front Renault tends to lead EU sales given its broad-span product portfolio from B-segment CDVs (car derived vans) right up to its class 7 HGVs and sizable dealer network. But the core products are the Traffic and Master, this latter van seeing model replacement this year. Renault has also maintained its manufacturing JV with Opel, assembled in GM's Luton, UK plant, and also rebadges product for Nissan Europe. Presumably Ghosn will be expecting the LCV and Truck markets to rebound from their heavy lows prior to proper traction in passenger cars in line with the economic upturn; when it eventually arrives, and will be directing RCI to prime business & fleet buyers with attractive finance terms.

Given present EU market constraint, Renault is undeniably looking for additional volume from the EM regions.
Brazil is presently 'flat' due to its own economic constraint caused by depleted commodities exports so whilst awaiting return, which is largely related to Chinese materials demand. As such, Renault like others is required to 'cherry-pick' its regional investment bets with the BRIC region during this global lull.

Russia, previously a rapid growth country has witnessed a heavy economic and consumer demand slump, 2009 car sales 50% down YoY. Although Ghosn was put under pressure by Russian production partner AvtoVAZ, he rightly did not cave-in to demands for additional liquidity, even at the threat of Renault equity dilution.

India saw Renault's relatively arrival late compared to the Japanese and Germans, but since 2007 Renault formed its 1st Indian JV with TATA in assembly of old generation Trafic vans. A 2nd JV with Mahindra & Mahindra to produce the (Dacia) Logan in Nashik, Maharashtra (at 50,000 units pa) and has invested in Chennai (to produce 400,000 units pa). A 3rd JV with Bajaj regards the concept development of a low cost “1-Lakh” car to compete with TATA's Nano. Thus it has set a synergies based template for car, van and truck JV's, aiding both the technical development of its Indian domestic partners and provides market access for its own indigenously manufactured and imported vehicles. Critically, the Parisian Board will be closely watching India to maintain its growth path as the other BRIC nations falter or slow.

China, and the Dongfeng-Renault relationship ran into trouble in mid 2009 after supposed Renault product defect problems. The original planned production plant in Huadu, Guangzhou City has been handed to Dongfeng-Nissan, probably to enable Nissan to maintain its sales lead. Although Renault cars will also be built there in realistically relatively limited numbers. Although Renault has been present in China for some time - though not as long as PSA - the ongoing capacity constraint regards domestic production leaves the company at a severe disadvantage compared to other, far better market-engrained western competitors, and so has in effect to catch-up with EU peers like the almost iconic VW (and sub-brands) and GM and late arriving but quickly established Japanese.

Thus for the present, although Renault may gain a larger share of the shrunken EU cake in the short term, it seems that Renault's primary BRIC focus is set upon India.

2. “Extraction of alliance synergies”
A decade since formation of the Nissan alliance and synergies have undoubtedly been captured, these opportunities creating challenges of their own both in-house and externally in the markeplace – everything from the previously mentioned operational problems of Nissan product quality defects through to at a strategic level the avoidance of product clash in regions and segments. But overall the alliance template created has worked inside the corporation's twin organisations, culture clashes largely avoided and efficiencies created.

Such lessons learnt though on a smaller scale, and the organisation of management inter-faces somewhat different, should serve the Avtovaz, TATA, Mahindra, Baja alliances and in time develop influence at corporate and perhaps political levels at Dongfeng & the regional PRC Administration.

In short Renault is having to create an evolved corporate template that is perhaps best described as a halfway house between its Nissan experience and that of smaller-scale regional partnerships such as Oyak-Renault in Turkey, or IDRO-Renault in Iran.

These developments are of course promising and already bearing fruit, such as Logan's reach into Asia. But the type of synergy-seeking will be very different to the technically based, new platform programme work achieved with Nissan – work that is well-structure and attains obvious cost-savings results. The synergies sought with its new partners will be far more market driven, and less 'controllable', with Renault having to diplomatically balance its 'ownership' of product and process with the political and cultural demands of its partners and the typically more volatile consumer demand of EM regions.

3. “Taking cost savings further”
This is perhaps the most visible sign of Renault's dedication to its future, competitive shape.

Though Renault shows a declining R&D and CapEx ratio relative to revenues, it seems increasingly hard to see exactly how it will attain the levels of cost savings without jeopardising future competitiveness. That is unless it possibly demands that Nissan become the major R&D extoller, and simply buys-in at cost the evolved technology with the hope of a maintained, and indeed increased, Yen vs Euro&Dollar differential - so assisting Nissan EU & US exports.

It seems inevitable that Renault is hard-pushed to create a more cost-drive value chain using BRIC located suppliers that are able to supply locally assembled cars (ostensibly the standard B-low cost Logan platform) with production capability for technically superior yet similar parts for EU-specified unit sales. This then provides R-N with a BRIC supplier base that is already effectively a generation ahead in terms of the ability to supplying for next generation local cars. And so Renault appears to have continued its philosophy of 'step-ahead, lowered cost' components sourcing, this created by the technical & procurement strategy template put in place originally for Logan and its CEE markets.

Thus the theory has been proven by CEE Logan and to an extent in Brazil, and so is shown to be viable. But the internal trends of these very different BRIC regions are very different to the CEE where Dacia was first and dominant. Renault cannot ensure such market and industrial dominance over the BRIC regions, especially so given its presently low capacity/volume levels. Instead of replaying the CEE model on an isolated basis in per region, it may need to consider creating a BRIC network of suppliers as a short-medium term solution, depending upon local BoM costs. Sub-assembly costs, FX relations, global shipping and local storage costs.

In short it will be harder to replay the Nissan or Logan cost-efficiency models given less control of a softer, more volatile macro-context.

4. “Sustaining a high level of WCR efficiency”
The creation and protection of Working Capital is of course a key determinant of long-term survival and success in such fragile economic times. For car-makers operating with global reach and so open to a broader palette of macro-economic influence it is vital. Thus no surprise that Renault highlights WC as a prime corporate lever, Ghosn knows that's investors wish to see that prime indicator of operational health.

But in these extra-ordinary times, given that Renault infact reached-out for the much needed $3bn aid-package, the present level of WCR seems far less credible, since it was not wholly the result of managerial acumen or astute capital management. Instead the capital markets could effectively assume that Renault (and PSA) knew that the socially-biased government as a large shareholder would ultimately come to its rescue and so as a consequence were previously more lax regards the honing of a truly efficient WC attitude. Had it been, it would perhaps not have required the E3bn, or if so, not as much.

Instead it is seen to be on par with PSA when the 2 companies are intrinsically very different, and demonstrating an awareness of “WCR” importance now seems almost a case of “closing the stable door after the horse has bolted”, if not verging on the hypocritical.

Instead it should perhaps highlight its ambitions via a more pertinent investor indicator Whilst BMW typically focuses upon RoCE and PSA now highlights its focus on Operating Margin, Renault will need to find an equally convincing 'financial hook', beyond still important but diminishingly so liquidity levels.

Vying against PSA on the Operating Margin measure, which itself is set against the “top-5 benchmark” could be that hook to regain credibility and a guide of relative future performance.

Renault will have to fight hard in Europe and Brazil whilst awaiting its 'Indian Summer', so should be seen to avoid simply buying market share via reduced margins; for that is a tactic that more investor-friendly companies (eg VW, Daimler, BMW, Honda) learned to avoid long ago.

In that respect relative to these 'capital-cautious' times, Renault must not be seen to be a quasi-nationalistic enterprise, but instead the truly globally capable, globally integrated, fiscally prudent blue-chip Ghosn envisaged.

The partial sale of Renault F1, and intended real-estate divestments help to illustrate the required mentality, but it must be seen not just in the Board's tactics or intentions, but created throughout the organisation down to a change in the innate reliance upon Renault's volume muscle and accordant pricing power.