Tuesday, 28 February 2012

Micro Level Trends – PSA & GM Collaboration – What Substance Behind the Rhetoric?

Last week saw reports that cross-party discussions amongst GM and PSA auto-executives at the 2012 Detroit Show were exploring the possibility of some sort of collaboration in Europe.

[NB, this was publicly 'ratified' by announcements on 29.02.12. Please view the attached Post Script at end of this item for reaction comment. investment-auto-motives stands by the argument for skepticism outlined below].

Investor's Reaction -

One autos analyst at a major investment bank reflects the central 'pros versus cons' dilemma as viewed by the investor mindset...

“Synergies between GM and PSA could thus ultimately run into billions - we estimate from 3 billion to 4 billion euros from joint purchasing alone – but it would take many years to deliver and, given the political sensitivity, would not come without significant execution risk either."

Background -

All auto-makers have obviously suffered across the EU region since the credit driven 2007 high of near 15m unit TIV in 2007 (only previously beaten in 1999), heavy demand contraction only temporarily buoyed in 2009 by massive levels of government intervention. Those monies directed to both sides of the consumption and enterprise equation so as to prop-up flailing economies; perhaps none more so than the exercises seen in the USA and France.

The historic plethora of 'national champion' VMs has led to on-going production over-capacity within the region, this the result of what could be described as a competitive tussle between largely 'free-marketeering' German producers (exempting Opel-Vauxhall) which sell on quality grounds, versus the oft far greater government assisted – and so endemically socially obliged – national producers of France and Italy which arguably sell on price and nationalism.

[NB it is noted that the this historic norm is being confronted by PSA & FIAT – and though 2008-10 conditions were an aboration – both recognised that a growing 'competitive disconnect' did emerge some years ago given the rapid pace of competitive landscape change (esp regards Japanese & Korean EU transplants) and their historic reliance upon state aid and economic up-swings].

Yet the past and present has, and still, sees decent margins for those able to operate a technically progressive and strategically adept automaker which has inherent 'brand equity'. That then is the goal for all participants, old and new.

The essential problem is of course that all seek that successful position, but very few truly possess it, and so whether ostensibly state-backed, parent-backed or presently successful in its own right. And thus complex, intrinsically nation-based, interests dictates that the status-quo continues even if through long periods actually economically value destructive. This problem sought to be overcome through alliance ventures with others, as seen with Renault & Nissan and FIAT and Chrysler.

But the fact of over-capacity and dwindled margins remains, the trade magazine Automotive News recently quoting statistics from PWC which indicate that by 2015 Europe's expected 112 plants will have an installed capacity for 22.84m units (vs 2009's 113 plants generating 21.1 million, and 2007's 117 plants with 22.4 m capacity).

Hence the constant expectation of alliances and joint ventures.

PSA & GME : Respective Positioning -

This story appears to be playing-out between PSA and GM Europe (GME), but is all as obvious as appears?

As investment bank analysts have been quoted, there are apparent product and manufacturing synergies, but also important issues relating to the capture or loss of strategic control.

As is the norm in the sector, both companies have track-records with alliances – in its broadest definition. GM has used them to both downsize its operations, with Toyota via NUMMI in joint venture US manufacturing, aswell as growing regional presence, as with GM-Daewoo as was (resulting in GM-DAT technical centre in Korea) and across China with SAIC, FAW and SAIC-Wuling; thus giving pan-Asia coverage and distribution leverage..

In contrast to GM's global dominance, the much reduced position of PSA in the 1970s – especially relative to Renault - meant that it has typically used JVs to critically bolster its product line – with the necessary exception of China's Dongfeng-PSA and Changan-PSA. Less well known is the relationship with Renault which operates 'Francaise de Machanique' and a share in automatic gearboxes. Conversely, most obvious alliance has been the 'Sevel' agreement in its LCV division including a derivative MPV with FIAT. This a JV precursor to projects with: Toyota for its 107/C1 A-segment car and Mitsubishi with its SAV (4WD) 4007/8, the very limited run 'iOn' city e-car and exploration with BMW into e-cars. However, investment-auto-motives suspects that far deeper collaboration has taken place regards compact cars, given the previous 'Prince' engine JV and the loss of 'contract capacity' for that engine which was destined to go to a now seemingly defunct SAAB, plus the innate ongoing margins pressure within the segment.

Thus, precedence demonstrates that GM exploited JVs to assist the 'right-sizing' of its older manufacturing base and new market strategy, whilst PSA uses alliances to support a full or expansionary vehicle range.

Thus on this basis of both companies' in market and manufacturing EU presence, there seems little obvious connect, apart from the obvious of co-ordinating where 'weaknesses' mutually prevail.

GM Europe in the form of Opel-Vauxhall has been essentially a perpetually loss-making division for decades, as with its US parent, its previous market dominance gradually eroded by others, itself able to maintain itself with US style sales discounting and incentives, a seeming necessary tactic even though its products have improved and essentially benchmarked as the norm by others, its 'yesteryear' and 'mainstream' brand personalities have prove a hurdle which both meant effective retraction from truly competitive executive style cars some years ago and little perceived personality amongst A, B, C and D segment vehicles even though more venturesome innovation efforts have been made, across Zafira, Meriva and Corsa. The corporate reaction to the 'over-stretch' Opel and Vauxhall suffered across all segments was the introduction of the lower positioned Chevrolet brand, seen thus far in Europe across the near full spectrum of vehicle types from the A segment (Spark) to the nuanced SAV and MPV segments, the same products represented in both, and far rarer halo cars such as Corvette and Camaro adding 'Chevy glamour'.

PSA's Peugeot and Citroen brands, once ailing marques, have in contrast managed to periodically refresh themselves through styling and target marketing, and have been able to demonstrate themselves as increasingly separate identities since their 80% + component and systems value share in the mid 1990s, that success allowing for wider design and engineering separation – though common modules remain key. However, there still remains a cause for concern that whilst the 'sportier'. 'younger' Peugeot is seen to sell itself with limited incentivisation, the more supposedly 'techno' & 'family' oriented Citroen is aided by discounting, the seeming necessary norm given the financial might of GM and FIAT to do so and the pricing pressure of rapidly rising Hyundai, Kia & Dacia. The move to create the 'pseudo-premium' DS brand has been its method to utilise systems share between both Peugeot and Citroen whilst also improving unit margins, growing a new facet to its group personality and so seeking to sustain its corporate autonomy.

This then provides a very generalised background.

Respective EU Production -

Unsurprisingly given the predominance of GM's established worldwide manufacturing footprint versus PSA's far later Euro+, MENA, S.America and China orientated sales push – largely from a Eurocentric hub - the two companies differ considerably.

A snap-shot glimpse provided by the Financial Times shows that in 2010 within Europe, GM built 1.464m vehicles (cars and vans) whilst PSA built 2.67m (selling 2.2m in 2010 and 2.0m in 2011). Thus the former had only – in very basic production terms – 54% of the production exposure of PSA in “broad Europe”. This important because of the traditionally high cost of European labour, especially so in respective 'homelands' of Germany and France.

However, note the major statistical difference within.

In Germany GME produces 530,000 units (rising to 730,000 including Poland). Whilst in France alone PSA built 1,465,000m units, effectively double that of GME. Exactly how that major difference is to assessed depends upon various productivity measurements, most notably respective labour force sizes, man-hours per (ex-factory) vehicle, the amortised S&GA overhead and CapEx depreciation rates.

In 2008 PSA had a headcount of 130,000, of which it is estimated that 70% (91,000) were located in France. Thus giving a general productivity rate in 2010 of 11.23 cars per person. Capacity utilisation for PSA across Europe was in 2011 approximately 80% (the nominal industry standard break-even figure), expected at 75% in 2012 given the demand fall in the domestic market.

GME, whilst positively with a smaller domestic manufacturing base, is expected to see a 2012 capacity utilisation rate of 65%. Yet whilst seemingly worse than PSA it should be remembered that it's out put is half of that of PSA at 1.1m units in 2010, and German manufacturing output is 530,000 units, which from a 2011 headcount of approximately 33,000; gives a productivity rate of 16 cars per person; better than PSA but highly inefficient relative to global benchmarks such as Korean manufacturers.

Euro-Market 'Quicksand' -

Such problematic top-line production figures, now below the standard 80% utilisation rate then are unable to absorb costs and so create a cash-burn at the operating level.

Whilst PSA partly restructured as a necessary aspect of accepting the E2bn soft loan from the French government during the financial crisis, it appears that it has been GM Europe which appears to be ahead in the industrial reformation stakes. This made all the more easier given that GME operates as a stand-alone manufacturing as sales division, whilst PSA includes its 'in house' Tier 1 suppliers of Faurecia and GEFCO. The critical aspect here being that GME may essentially more easily massage its transfer-pricing of supplied engines and gearboxes from its facilities in Austria and Hungary; whereas Faurecia and GEFCO may have sought to defend their income margins from parental pressure, as looks to have been the case when viewing the divisional income breakdown in the annual report.

However, progress is relative, and whilst GME looks good compared to PSA, its unfortunate position of having to constantly “do more with less”; whilst other specific German, Japanese and Asian rivals are winning market share, expanding their European and global volumes and so able to better finance product and corporate ambitions.

To try and remain competitive GME's has stated ambitious R&D and product actions relative to its income. But that means that strategic planning effectively becomes ever harder and contains more inherent risk; whether that be the importation of lower quality vehicles which provide unit margin but degrade brand perception, or the allocation of R&D and innovation funds in specific low-impact or high-impact technology solutions.

The Earnings Perspective -

In Q4 2011 GM Europe reported an EBIT-adjusted loss of $0.6bn, which included $0.2 billion of restructuring costs - thus matching last year’s results. This Q4 'hit' was rolled into an FY2011 EBIT-adjusted loss of $0.7 billion in 2011, showing improvement over the negative $2.0bn loss in FY2010.

[NB. This sits within GM's total worldwide Q4 2011 revenue of $38.0bn (+3% YoY), a net income of $0.5bn (or $0.28 per diluted share), which when EBIT-adjusted reaches $1.1bn. And an FY2011 net income of $7.6bn, which when EBIT-adjusted reaches $8.3 billion; up $1.3bn versus 2010].

Tellingly PSA did not provide a quarterly update for 2011, simply giving H1 & H2 accounts, which may be theoretically de-constructed by to provide a basic appreciation of PSA's European performance.

For the full year overall EU market sales share slipped by 0.9% to 13.3%, the A & B segment down by -1.1%, and the very positive 7.3% per car contribution seen in H1 reduced to -1.7% in H2. The Group's overall Operating Income / EBIT was E898m, down from E1,736m in 2010, this infact buoyed by positive contributions from Faurecia, GEFCO & Banque PSA Finance against the Vehicle Division's E-439m loss (vis a vis E563m the previous year).

Importantly PSA saw its balance sheet alter significantly as its Net Debt position nearly tripled and its Gearing level rose from 9% at YE2010 to 23% at YE2011, which indicates that deep structural reforms of the Group could well be on the horizon

Conclusion -

On balance, investment-auto-motives believes that PSA and GM will not collaborate in any meaningful manner on the core of small & compact cars, ie the B & C segments between 1.0L (inc the 900cc 'triple') to 1.6L; the arena of so much auto-industry, press and investor speculation.

Whilst both companies similarly recognise the need to constantly improve product quality in what are the European core segments - and increasingly 'B' as the 'global segment – and so collaboration appears a natural presumption, the fact remains that both GM and PSA will want to control their own destinies relative to such strategically important market sectors; the latter if necessary leaning upon its technically enabled BMW German links.

The only reason to contravene this stance, were if PSA sought to introduce a new entry level brand – in the Dacia manner – which would necessarily demanded a low-cost / reduced quality alternative approach, which itself could utilise either its own last generation platform or that of a (GMDAT) Korean product as its base. However, given the historical independent stance of the controlling Peugeot family and the similar independent PSA corporate mindset which must build “PSA DNA” into its cars, this seems unlikely.

So once again investment-auto-motives suspects that Thierry Peugeot and PhilipVarin will maintain a continuation of the Toyota relationship in this field, especially as a less problematic solution to replacement of the Aygo based 107, But more importantly, because of Toyota's own 21st century corporate centrality and R&D exploration of city-cars. Thus new agreements could be drawn-up which replay of the Aygo-107/C1 deal, whilst adding yet a possible plethora of Toyota sourced small and city-cars to the PSA stable, such as the 'sliding door' Toyota Porte which could replace the novel yet defunct 1007. This would offer a cost-effective and ready-made product stream for PSA as it seeks to 're-animate' in Peugeot and Citroen guises 'Japan-only' vehicles (inc kei-sized commercials) via low cost 're-skins', as it itself through initiatives such as 'Mu' seeks to become a branded transport provider, as opposed to a conventional 'production heavy', and arguably production trapped, conventional automaker.

Under this scenario, those PSA owned production plants that are potentially divested would be run or purchased by Toyota, able to leverage its strong Yen to positive FX effect, whilst continuing to de-industrialise its over-costly Japanese operations.

However, that does not discount GM's possible importance. Given the potential size of the ongoing asset disposal programme at PSA, GM could be utilised not as an operational partner, but as a potential facilities purchaser.

GM Europe imports small Chevrolet branded cars from Korea and USA, a situation which to date has been favourable because of FX tailwinds, but the much strengthened Won and recent re-strengthening of the US Dollar, means that a continuation of such a ploy only means that ant Chevrolet growth inside the EU is much undermined by the FX differential between US, Korea and Europe, this much exacerbated by the ongoing long-term devaluation of the Euro. Thus the use of discounted priced factory facilities, assisted by much reduced overheads and operating costs enabled by massively altered new labour-force agreements would be attractive.

Thus GM's Chairman and CEO Dan Akerson may well desire an ever more cost-effective manufacturing base situated within Europe, but PSA's major shareholder Thierry Peugeot and its CEO Philip Varin will seek to use the deflation of the Euro as a central pillar in their own export expansion drive where feasible, as well as a solid raison d'etre behind increasing ties with BMW given their similar single currency positions.

But for the moment, investment-auto-motives believes that whilst basic exploratory talks may well have taken place behind the scenes in Detroit 2012 – and indeed may no doubt be being more deeply assessed both in the Renaissance Centre and across the Atlantic in the Grande Armee – the idea of platform sharing is a remote one.

Whilst there are packaging and stylistic similarities, PSA's chief engineers will probably see very little (if any) 'engineering envelope' remaining at a systems level from which to develop both a sporty Peugeot derivative or comfortable citroen vehicle from the GM Spark - given its basic engineering origins as an ostensibly low cost, low priced item aimed largely at EM regions.

Yet, both Akerson and Varin innately recognise that within a new era of long-trend diminished EU sales, the primary interest (behind the immediate talk of product and supplier synergies) is that of GM's own EU market growth interest for Chevrolet.

And that GM's own long-game is to capture a low CapEx route that may combine Chevrolet's in-market production and sales ambitions across Europe, whilst also integrating Opel-Vauxhall platform efficiencies so that they may benefit from improved and better directed R&D expenditures.

GM undoubtedly seeks to take 'Monsieur Chevrolet' successfully back to his (its) homeland. And hopes that the its corporate 'bow-tie' will find favour on the back of that once famous breed of cattle. Eventually to do as much for US-French commercial relations as 'de Nîmes' sourced 'Denim' cotton did long ago.

Depending upon the PESTEL views taken by Thierry Peugeot and Philippe Varin potential and the relative probability and impact of various tailwinds and headwinds – ranging form a beneficial deflationary Euro to possibly protectionist EM regions – PSA should have room for manouvre between its seeming courting rivals of GM and Toyota. But in the meantime PSA must be seen to be adding far deeper strategic thinking behind the 'headlines' of its 2012 Plan; and that includes meaningful strategic and financial 'value extraction' from GM and Toyota.

Post Script -

The viewpoints stated by investment-auto-motives obviously run counter to the GM & PSA announcements dated Wednesday 22nd February.

This highlights an apparent £2bn per year synergies to be obtained in small and compact cars.

Whilst synergies undoubtedly exist in mutual commodities/materials purchasing (esp steel via Varin's connections), and in certain 'near & far horizon' R&D, aswell as in potential for a shared E segment vehicle programme (608/Insignia), investment-auto-motives believes that ultimately an attempt to co-alesce mainstream small and compact programmes will ultimately prove technically frustrating, even with a repositioning of Opel, Vauxhall & VXR brands to mirror Citroen, Peugeot and DS.

Thus the 7% stake by GM is, it is believed, a move to allow internal insight into PSA so that it can be 'remotely supervised', as is so often the real case behind competitor investment stakes, aswell as provide immediate knowledge and influence in PSA asset disposal vis a vis GM purchase issues.