Saturday, 24 April 2010

Company Focus – FIAT SpA – Family Planning

From the long-view perspective FIAT Auto has ridden tumultuous, good and troublesome times over the last decade. The potential energy for its previous turnaround was actually created by the effectual cash injection brought into play when GM decided not to take its 'call-option' on the then flailing Italian firm, and instead had to pay its way out of contractual obligations. Those monies were used to buoy FIAT, its brands and credit division which with the help of asset and balance-sheet leverage enabled FIAT to create a virtuous circle of product development and credit availability.

Of course late 2008/9 saw the credit bubble burst which impacted FIAT's (and many others) business models – including the US auto sector. With a contrarian mindset, Marchionne took the challenge as an opportunity to court Washington to create a performance related 'equity walk-up' deal for Chrysler, and although a hard task master, at least the apparent savior of the smallest Detroit player.

FIAT is undeniably battered, as are most, but having weathered the storm of the last 2.5 years and noting the recent term stability of risen capital markets, the FIAT Board see the time as right to present its future to the investment community. As a signal of refreshed mid-term optimism is the appointment of Agnelli family heir John Elkann – who heads the family's Luxembourg based investment fund Exor - from V-C to Chairman; so replacing Cordero di Montezemolo.

[NB Exor sits within the master investment holding company Gianni Agnelli & C. Sapaz].

Importantly, Elkann's dual role as both head of family investments and the cars division indicates progression toward the unbundling of FIAT Group divisions – Auto, Iveco, CNH Global, Magnetti, etc. This strategy means that FIAT Group retains Autos as its central pillar, but evaluates divestment of the remaining.

As witnessed, first off the block is release of Iveco, CNH, FPT Industrial and Marine merged to form an 'Industrial Vehicles' business. That leaves Auto with: FGA, the Chrysler stake, Ferrari, Maserati, Magnetti Marelli, Teksid, Comau and FPT Passenger & Commercial Vehicles

This news boosted the company's shares on Milan stock exchange by 8% almost immediately, demonstrating the air of expectation that something big is in the works – very typical of historic major Milan market moves where nuance over-powers fundamental metrics.

The Q1 2010 results were set out as a game of 2 halves, the nominal last quarter sales, revenue and profitability report, aswell as the presentation of what seems essentially Marchionne's 5 year plan.

Q1 Results:
investment-auto-motives expected less than many in Milan, the City or Wall St; and it proved so. Given the structural market headwinds and the retraction of EU scrappage schemes – in which FIAT was not a prime beneficiary outside of Italy – and indeed its poor alignment to such scrappage schemes without a true B-segment car, the inability to claw in greatly expanded revenue was always to be the case. In effect, having seen much of the incurred cost to generate latter efficiency gains from previous structural downsizing, and the sizable loan repayment to maintain a plausible credit rating, Q1 was always set as a period of the Auto unit ostensibly 'treading water' (although at a quicker pace awaiting full swim) as far as external observers were concerned, and so a continuation – though at far lower level of net losses. (Q409's E-283m / $380m). To expect more was perhaps naïve, but nonetheless the improvement on 'paper-based' reasoning is momentarily encouraging., even if overshadowed by the 'family planning' announcement that added upward and concomitant downward price volatility.

Using LSE/ThomsonReuters data, Q1 offered revenues of E12,926m (vs Q109 of E11,268m), EBITDA was not stated, but EBIT offered E352m (vs Q109 E-129m). [This E352m faces an estimated average of E345m from FIAT listed external investment analysts, as reported by Bloomberg; and as one analyst correctly states “results broadly in line with forecasts are not market prompters”]. Pre-Tax Profit was E157m (vs Q109 E-360m), Net Income was E-25m (vs Q109 E-410).

Within this given FIAT's 20% Chrysler stake – intended to raise to 35% in 2 years – the US company's tax-payer funded turnaround seems underway, with Q1 showing a loss of $197m, markedly smaller in comparative terms than the June 10th to Dec 31st 2009 loss of $3.78bn – though this comparison has obviously been chosen to flatter given the odd June 10th date elected. ($2.1bn of this was a charge to the UAW healthcare fund). Marchionne however was proud to state that Chrysler gave an operating profit of $143m demonstrating its improved break-even level at 1.1m units in the US. In an improving US market TIV, it was stated that revenue is expected at $40-45bn, with EBITDA of $2.5-2.7bn. Cash at hand (presumably of all liquid instruments) increased to $7.4bn from $5.8 at year-end, with an additional $2.4bn available from US & Canadian government sources. Q1 market share was up in the US, Canada and world-wide to respectively: 9.1% (from 8.1%), 13.7% (from 11.6%) and in vehicle terms global sales reaching 334,000 from 318,000.

[NB investment-auto-motives believes that given the strength of competition, and Chrysler's lack of small cars, this was probably largely achieved via incentives on passenger cars and the revenue input of ever faithful Dodge Ram truck buyers].

The 5 Year Plan:
Marchionne states that it has been recognised that for some time the transparency of FIAT Group has been lacking, thus creating a harder detailed forecast picture to be painted by both sell-side & buy-side analysts. That inter-dependent structure has however played a vital role in leveling out the cyclical nature of FIAT Group's separate divisions, especially Autos. However that was through historically normative economic cycles. Yet (apparently similarly to FIAT thoughts) investment-auto-motives believing that the 2008 western crisis changed the 'normative', each sector effectively individually starting from scratch from 2010 onwards, hence the logic to largely unbundle. This unbundling a very necessary feature if the western auto-industry is to be re-aligned along more lateral lines instead of its historic vertical value-chain to improve investment rationale and RoI.

Automotive News' post report identified its 'primary takeaways' of the announced plan as: Autos saving $4bn by 2014 in combined purchasing, Chrysler worker retraining and $126bn in revenue earned by 2014, that very year supposedly offering E64bn in turnover of which giving E3.8bn in trading profit. (FIAT's definition of trading profit being the subtraction of top-level costs and additional extra-ordinary costs – typically restructuring costs – thus a measure providing far greater flexibility to achieve).

[NB by its very nature FIAT has re-orientated the adage to set a E64bn question!].

The 2014 financial goals for the new Industrials division are a turnover of E29bn giving a trading profit of approximately E3.3bn.

Interestingly the Group's debt present debt structure will be evenly split between Autos & Industrial, that debt rising from E4.4bn year-end to E4.7bn by end Q1; hence its seems that much of the debt incurred to date for Autos is disproportionately being given to Industrial, adding to the chance of financial performance improvement for Autos in the mid-term.

And it may well need it, if new product cadence does not live-up to ambition.

Looking forward...

Marchionne of course recognises that FIAT has not marketed an archetype B-class car in Europe for some years, instead hoping that the introduction of a (new) 2011 'Novo Uno', fills the void between Panda and Grande/Evo Punto. Hopes are that it can replicate the success of original Mk1 & Mk2 Uno between 1983-1995 (though maintained in EM regions under different names with evolved body-styles), and the idea to both drive economies of scale from a shortened Grande-Punto platform and simultaneously obtain conquest sales from largely French (Renault & PSA) and Korean (Hyundai & Kia) competitors, aswell as of course GM Corsa and Ford Fiesta, yet using Japan's Mazda 2 as the BIC benchmark. Interestingly, initial pictures suggest it takes on a more functional aesthetic than its more svelte peer-group, mimicking with softer lines the clean boxy, partial asymmetrical detailed, appearance of 1970s o/Strada and 80s Uno.

If this is indeed the case the styling ethos appears to visually merge the historically separate offerings to EU and EM markets, no bout heavily influenced by Chinese acceptance of visually simple body-styles. Thus FIAT hopes to expand its RoW design philosophy into Europe. How ultimately successful this will be in practice is in Europe open to debate, but in an age of 'classy super-minis' from most manufacturers, including increasingly the Koreans, the concern is that Novo Uno is perceptually lumped together with more utilitarian cars like Dacia's Sandero.

FIAT obviously wishes to differentiate itself, and needs a suitably clean body-style onto which it can graft Dodge and even Jeep identities, but will need to better explore how a 'functional aesthetic' should be conveyed so as to be aspirational. Not doing so will only create a pricing pull-down effect as EU potential customers re-classify FIAT's small cars as increasingly 'cheap & cheerful', and discordant with the more up-market image of 500, and Abarth performance variants. The 21st century EU is far more complex than 1960s Italy or 1980s Europe.

Marchionne is aiming at 35% of Chrysler in 2 years time. That will depend upon a success FIAT rebound, itself dependent of a managed mix of both, a) new vehicle offerings which the markets will embrace (harder in Europe & the US) and b) the manner in which FIAT Group (inc ultimately Auto – though not stated) is divested and re-equitised, so as to give FIAT Auto and Exor (via Elkann himself) as large a return as possible to re-pump back into Autos thus able to acquire a latter-day increased stake in Chrysler.

The new added transparency provided by a split conglomerate will of course help external valuation and, as the WSJ states, the 'conglomerate discount' presently seen should wain. It recounts Credit Suisse's estimation that at E10 per share FIAT trades nearly 30% below its nominal E13.90 for the sum of its parts. (investment-auto-motives has not undertaken a similar proportionate evaluation and so cannot ratify that figure. Typically conglomerate discounts run at 15-20%).

Moreover, investment-auto-motives believes it would be only natural to suspect that over the last each of the individual companies have been reformed so that respective balance-sheet accords 'light-values', especially regards heavily written-down asset values, boosted cash reserves and other accounting tactics – the natural schema for what could well be a stream of spin-offs from each of the 2 new divisions, with probable doubt latter-day re-ties on an independent basis between Auto & Industrial sub-units

[NB investment-auto-motives believes that one such examplar could well be that the Industrial Vehicles business may in due course absorb FIAT's small van business 'FIAT Professional' to better separate the car-derived vans from the van-derived cars in FIAT Autos range. This separated relationship for Iveco thus increases its commercial vehicle range, provides for greater leverage of unfettered fixed transfer pricing of goods sold by Autos to Industrials, but interestingly also allows the new Industrials division to overlap the technologies and systems of vans/trucks and tractors/diggers etc.

This not only generates synergistic savings but also provides promise for vehicle overlap, such as that seen by the successful JCB Fastrac, which measurably changed the AgCon vehicle playing field. To do something similar would be of great advantage to FIAT given its EM exposure]

As for the tactical timing of the FIAT presentation itself, very probably to over-shadow the relative financial quarter under-performance that could alone have damaged share-price, with the market promise of “jam tomorrow” - and it seems to have worked.

This presumably intended to put a new perceptional share-price 'floor' for the Group at the E10 – 11 mark, which in time will improve due to the income effect of Autos enjoying slow but stable market-tide growth, and in turn raises the very generalised apportioned valuations for each division when separation occurs; the current investors expected to receive 2 shares of the Industrial Division for every 1 Group share owned.

Thus FIAT is using a 2-stage ploy by which to increase the value of each division when they eventually individually come to market.

So whilst the Torino FC readies itself in its fight back to Seria A after its relegation, across town in the industrial and financial realm FIAT Group is readying itself for a continuation of its fight on the national and world stage. Given that Marchionne's expects domestic car demand will fall 30% and EU demand 15% in 2010 FIAT must face yet another trialling period; in the belief that challenges bring eventual opportunities.

[NB the FIAT TIV forecasts are believed by investment-auto-motives to be over-exaggerated, so as to assist Autos beating self-set and externally set earnings guidance).

However, as Marchionne well knows, presently the over-capacity of European autos will keep generating long-term value-destruction until the (long-awaited) shake-out to his quoted 6 players emerges.

The scrappage scheme has assisted FIAT enormously, especially domestically, eve though the strength of its BIC low CO2 emissions ratings (possibly inadvertently boosted by lack of a B-segment car) was ultimately hindered by the reduced appeal of its aging product.

But, the question for most investors regards the auto-industry – especially after GM & Chrysler bankruptcies and EU bail-outs, is the innate value of an enterprise if stripped essentially bare. This is presently an academic exercise given FIAT's capital market credibility generated to date, but if seen from PE eyes - beyond the dynamic of hazier public capital markets - the harsher, real test is that of 'on-paper' value vs 'bare asset' value. As of Q1 2010 FIAT reports its value as E68,027m: the Equity & Liabilities value = Current & Non-Current Assets value). Remove the Asset-Backed Finance Payable of E7,482m and a sub-total of E60,545m appears (as FIAT displays). Remove the Unsecured Financial Payable of E20,818m and the new sub-total of E39,727m appears. Remove the Equity level of E11,457m and the new sub-total of E28,270m appears. Remove General Provisions, Employee Benefit, Trade Payables, Taxes and Other Liabilities of combined E36,746m and the new subtotal reads E-8,476m. Remove Intangibles/Goodwill of E7,446m and the final total reads: E-15,922m. FIAT Group when stripped bare in its consolidated conglomerate form, fundamentally operates as a value-destructive enterprise to the tune of E-16bn.

This is admittedly purely a paper-based, academic exercise but it underpins the Agnelli family's raison d'etre that Marchionne perceptively release and separate FIAT's internal value-creation mechanisms so that they gain market-reflective values and can have the autonomous futures to best ride the separate sector-relative economic upturns when they arrive.

FIAT is a long way from being out of the woods, with the mainstream FGA element still facing market headwinds, but the basic industrial plan of separating into 2 distinct enterprises has shown to win market favour. But much remains in the execution, the debt burden playing a critical role in the short term, as will generated synergies and the ability for any full transfer-pricing between the 2 divisions and within a division as each company is tasked further to seek a greater portion of external non-FIAT business.

But ultimately, investors will be asking themselves not only about the new Industrial division's PaT, but if it will be used as a FIAT Autos 'Patsy'. The question being: will it be laboured by Iveco's having to buy Auto's car-based small & medium vans and FPT engines, gearboxes & other components at full market rates, to ultimately help bolster Auto's revenues and margins? If that is part of the invisible big-picture – and reasonable to think so given Marchionne's “New FIAT” ambitions – pressure will be put on the new Industrial division to both grow at a pace for each company beyond their respective sector TIVs, but also seek-out mutual programme development, technical systems and production-build synergies across the Iveco – CNH – Marine group.

Ultimately, in the quest to become a truly viable 'sexy' global car company, the FIAT board will need to try and avoid Industrial (FI) becoming the inadvertent 'whipping-boy'. As Elkann, Marchionne et al develop their IPO plans – as part of the new transparency edict - that is perhaps the central investor issue that requires elucidation.