Monday, 17 September 2012

Company Focus – Peugeot SA – Positive Climb or Momentary Reprieve?

The general pan-European stock-market collapse which started in late March this year hit those who were viewed as most exposed the hardest. Few saw innate corporate value destruction to the same extent as Peugeot SA.

From a YTD high of E16.31 on 3rd February, the slide took seven months to perceptively bottom only very recently on 5th September at E5.74.

The question many are asking – institutional investors, the PSA Board and crucially the new French government alike – is whether the recent impressive rebound is simply a 'bear share' rally promoted by the ECB's recent macro announcement (to effectively back-stop the Euro via European banking system through national bond purchases), or whether this rebound can be sustained in the medium and long term by execution of the present and future micro 'turn-around' plans within PSA.

Basic Situational Analysis -

That rally has been accompanied by a number of beneficial and damaging factors:

Beneficial has been President Hollande's recognition that job cuts are indeed “inevitable”, an important tailwind for the group and a strong 'real-world' stance by Hollande given his socialist principles (The fact that his presidential victory drive was in a PSA vehicle, himself stood through the car's sun roof, yet in the pouring rain, was viewed by investment-auto-motives at the time as highly prescient).

The outcome, a retrenchment process that will see over 8,000 posts eliminated or re-classified, and the high-cost Aulnay plant near Paris shuttered. To assist the balance sheet, the ongoing divestment programme, with sales of property assets through the summer, now sees 75% of the group's Gefco logistics division being purchased by OAO Russia Railways. Though not yet officially 'sealed' yet, it suggests that operational logistics loss would be substituted within Europe by the logistics agreement wrapped within February's GM agreement. The sale to OAO also obviously boosts industrial and political relations with Russia, an increasingly important marketplace and industrial space for PSA.

Previous PSA investors were somewhat 'diluted' by the much needed new E1bn share issue in early 2012 which itself help drive down the stock's valuation in the short term, but provided improved confidence for the mid term. Viewed negatively has been the demotion from France's CAC40 index, reduced expectations of the previous manufacturing alliance with GM, and release of an independent report which berates PSA's primary shareholders for “strategic errors” to date.

The fall out of the primary index is seen as a fall from grace, an embarrassment itself. Yet out of the direct spotlight provides the fortuitous ability to not be 'tossed and turned' by reactionary CAC40 sentiment, especially when it recedes. That should mean that its share value and so market capitalisation will better reflect informed investor opinion, and the meaningful research of institutional buy-side analysts and private investors alike. This should provide a firmer financial base from which the PSA Board can execute the intended turnaround.

Interestingly, in a volt-face, it appears that GM is unwilling to share its medium/large -size vehicle platform, which PSA was due to adopt for its large sedan/wagon cars. GM China stated that offering the platform would enable PSA to directly compete with GM in the all important Chinese market. (This issue should have been 'baked into' the original agreement via a production clause, but serves to demonstrates the lack of engineering – or indeed corporate - compatibility that investment-auto-motives highlighted after the February announcement).

A Rhetorical Report -

The independent report was commissioned by the government and undertaken by Emmanual Sartorius. Its results stated that PSA was/is/has:
1. late in achieving cost savings between the Peugeot and Citroen divisions
2. overly reliant upon the European car market,
3. had little foothold in emerging markets
4. had not formed an entwined strategic alliance in the Renault-Nissan manner
5. had no reach into the premium car segments
6. overtly controlled by the major shareholder interests of the Peugeot family

But in truth, most of these strategic shortcomings were recognised by the company some years ago, there is little of true insightful value from what has been reported.

Well Recognised Challenges -

Historically PSA has been a leader regards its internal cost equation across its two brands, the mid 1990s seeing the pinnacle of Peugeot-Citroen systems sharing, an industry leader at the time. Progressing this background, it has been the impressive manner in which the newer DS sub-brand has been platform engineered – splining Peugeot & Citroen systems to create something new which offers the much needed cost-down and up-pricing efforts.

The product strategy and engineering elements of the company appear fully conversant with the present-day challenges. Their own strategic options pallet is limited to extricating internal value on core vehicles and buying-in platforms and expertise for fringe vehicles. This the case for many years and central to PSA's long-standing business plan. The greater challenge, still well recognise by Varin et al, is wholly structural regards its fixed and variable cost—bases, primarily about production efficiencies but necessarily spanning the whole organisation. But beyond even this cyclical reaction is the need to wholly re-orientate the complete business model so as to become a progressive thought leader in 21st century products and services provision; with acccordantly strong internal and external value chain(s) reach.

To this end the challenge is greater than expressed by general commentators.

Signs of a ttrue desire to metamorphosise into that 'future company' have been evident since CEO Varin's appointment; given his steel-sector roots and the need to redefine the buyer-supplier relationship, and new (still relatively tentative) initiatives such as the ‘Mu’ programme which seeks to offer personalised flexible transport solutions and better match multi-vehicle useage patterns to user needs.

So the ‘deep and far’ reaches required whilst not wholly evident in the present commercial shape and revenue streams of the company, especially given the required sale of Citer vehicle rental business, look to be seeds of the future.

Talking Heads Defy Progress -

Bloomberg TV have had talking heads stating that PSA should: cut capacity, introduce appealing products and find new routes to market. Whilst useful for filling the ‘media air’ this states little more than the obvious. How this is done in execution, as part of the short, medium and long-term structural solutions, is what matters.

Meaningful Macro -

Unsurprisingly, the most pressing issue is macro-economic in character.

Presently the likes of PSA and many similar European companies presently suffer as a direct result of the sovereign-debt crisis, so in recent times greatly dependent upon expectations regards the nature and timing if the liquidity feeding mechanism promised by the ECB into each EU state’s banking system.

Given its primary role, Germany’s reticence about such notionally heavy-handed QE measures is more than understandable, whilst by procrastinating, also assists the competitive advantage of its own auto-players.

Yet the fact remains that the ability for PSA to access cheaper wholesale funding, given its lowered investment grade status, remains vital. In order to underpin Banque PSA in for internal funding needs and its own vehicle sales/leasing activities externally.

Presently that situation appears “critical but increasingly stable” thanks to much improved national debt management conditions and less stressed capital markets, and the company's ability to access low interest capital with balanced income vs maturity schedules; but tensions invariably still exists.

Mending the Micro -

But of course, ironically, it is largely the apparentongoing instability of cross-border European banking at the macro level which at presently enforces the strict discipline of fundamentally re-shaping the company’s micro-level cost-base.

[NB Intelligent investors closely will monitor exactly when divestment and cost reduction programmes have gained internal traction and wholesale liquidity access is externally forthcoming].

Much has been said about PSA’s over-reliance upon its European sale-base in H1 2012 (giving 58% of its income) relative to its limited but slowly growing presence in many higher-growth EM markets.

However, as some of those ‘over-heated’ EM markets slow their own growth rates (esp Brazil &  India), and install policies to support indigenous producers, so the CAGR rates of the previous opportunity momentarily abate, though overall volumes continue to swell. Vehicle price wars within those temporarily squeezed markets are not the right context for expansionary marketing and maintained margins of a 'quality' European vehicle. However, the respective proximity and size of Russia and China appear to provide greater incentive and lesser immediate market headwinds, so the need to maintain sales push to continue the mutual small but important market share growth rates over H1 2011 in what are the world's strongest growth geographies.

Though it may seem illogical given the constant downcast commentary on Europe, PSA’s strong foothold of 12.9% must be defended. There is the possibility that the less financially constrained UK where sales are slightly up, can be used as a ‘beach-head’ whilst awaiting the ECB's liquidity feed into Southern European banks, and trickle-through to the vehicle sales base. Of great importance has been recent recognition of France's reduced sovereign debt woes. Plus, Scandinavia's buoyant economic standing. Together, this golden triangle may act as the foundation for the long awaited European sales expansion.

PSA is indeed a “generalist manufacturer” and has been increasingly squeezed between an ambitious and expanding VW Group, the dividing of the mainstream mass market by quality and affordable players reflected by the Germans and Koreans, with the Japanese increasingly positioned as the newer mid-tier occupants. Hence the continuing loss of European market share by the old guard Opel, FIAT, Renault and PSA. The de facto reaction has been to create low cost cars (indeed whole platforms) such as VW’s original efforts with Skoda-SEAT, and Renault’s impressive deployment of the Dacia cars from re-engineered old generation platforms. But, broader Dacia sales have recently contracted, given across the board EU and MENA woe, even with new purchase appreciation levels amongst shallow pocketed westerners.

To this end, though arguably late in the day, PSA announced of the new 301 budget compact sedan/saloon. It strikes at the heart of EM nations’ preference for sedans (family transport, taxis and company cars) and will provide for a valuable resuscitated income stream, especially in MENA regions (see below) and China.

[NB It reflects the new naming structure which sees use of the suffix ‘1’ applied to specific EM market vehicles].

Extolling European Product Advantage -

Over the last 15 years of so during EM region economic expansion, cars like the ooriginal Skodas and SEATs and Dacia's were perfectly designed to appease the motoring desires of th new middle classes. But they have also seen and experienced those other more advanced and desirable vehicles that had been previously beyond their reach.

Now required are meaningful, 'par-excellence' affordable motoring products that have been originated in, and dedicated to, Europe and made avalaible elsewhere. High impact, demonstrably 'new era' vehicles, which are released onto the international stage with intrinsic European kudos, manufactured locally alongside EM dedicated products. The FIAT 500, Ford Fiesta and VW Up create the template, yet PSA (and Renault) could make strides by further extolling its European roots.

Looking at the small car sector in Europe, presently, Opel appears rather hamstrung in its efforts with the new Adam. Although referancing the originator Adam Opel it has little inherent cultural meaning to the masses outside of Germany, and its mixed concoction of retro-modern styling cues without definite heritage provides little credibility. Conversely, FIAT leads the pack with its range deployment of the 500 persona, now arriving in different variants and guises, obviously mimicking BMW's Mini. Renault has shown little thus far, but a re-invention of its original popular Twingo – to overcome the present lacklustre vehicle and contrast the new generation sporty Clio – looks inevitable.

Peugeot’s New March -

With such strong competition abound and expected, having seemingly well engineered the impressive new core model Peugeot 208 it must now be properly supported by sibling products and powerful marketing to maximise sales traction, and maintain clear differential between it and its sister Citroen C3.

PSA must broaden its concentration on re-inventing its A-segment 108 and C-segment 308. The 108 will be a replacement for the long-lived Toyota Aygo based 107, suggesting an on-going product replacement agreement with Toyota for something far more impactful than the designed for production Aygo/107/C1. Whilst the 308 will have been engineered in a module constructed manner alongside 208 to generate fixed and variable cost savings over its prime models.

As stated previously by investment-auto-motives, an exhaustive exploration of how PSA and Toyota could further integrate respective interests would be most pleasing, given the useful but limited results with Mitsibishi. After the very successful Renault-Nissan merger and the recent Mazda's sportscar agreement with FIAT's Alfa Romeo (expected to expand) continuation of Euro-Japanese meshing is compelling; VW's retraction from an alliance with Suzuki possibly the very well rreasoned exception that proves the rule
Toyota's need to equally alter its historic 'wholly controlling' business model and better commercialise its R&D means it could be receptive to a definite but loose industrial arrangement with PSA.

The upcoming Paris Auto Show unfortunately looked originally set to under-whelm. PSA re-exhibiting the SR1 large coupe concept alongside the new HR1, 'old' Revolt and new 2008 concept, in addition to its web-presented new and re-hashed concept cars, the inclusion of the new 208 GTI and SY variants seeking to create a link between the now and tomorrow.  However, it seems that seeking to provide a late talking point, he company is showcasing 40 models to contrastedly 'overwhelm' the show and demonstrate its French and European muscle; a good PR initiative.

[inserted PS...the surprise Onyx showcar provided a good contextual description for the PSA, having to create a 'twist on convention', doing so with carbon-fibre and copper mixed material surfaces on conservative supercar proportions].  

In truth the present ‘public form’ of Peugeot especially in the critical advertising space appears poor, the new 208 especially so in the UK market, given its critical importance and the rather aneamic TV adverts. Here in the UK, at this proverbial 'beach-head', Peugeot tends to sell to singles and couples with greater disposable incomes (the RCZ the halo), whilst Citroen has greater family-market targeting, who themselves are heavily cash—strapped at present. Thus the focus on Peugeot and DS is understandable, with even momentary re-orientation of Citroen, since they will be expected to help off-set the lost (usually trade-in replacement) sales of Citroen.

Eactly how the DS sub-brand is managed hereafter is of vital importance if it is to gain popular respect and improve upon its novelty status. It realistically gains its higher price-point from being positioned as characterful, technical and customisable; yet cannot be labelled truly ‘premium’ (even if PSA seeks to do so) until its build quality and residual values are proven over the years to come. Managing the DS range may prove problematic into the future since the DS3, DS4 and DS5 share little family resemblance amongst themselves, and are extremely distant cousins of the original DS

As stated by investment-auto-motives some years ago, PSA should create a type of entry-level, affordable ‘ID’ brand so as to create a diamond-like brand positioning pattern in the all-important European market, itself able to be replayed across the globe later.

Necessary Contrarianism -

But, it is the MENA region which could offer a substantial mid-term boost. The new 301 demonstrates renewed commitment to the region, set to replay Logan’s success, but perhaps moreover.

It should be remembered that PSA did much to assist Iran when it sought to update its own auto-industry in the late 1980s, replacing the old Peykan with new Peykan/ Samand / Soren based on the 405 body-shell, with later engine and cosmetic updates. The new 301 could provide a new Iranian car programme, replacing or accompanying Soren.

To do so may presently be seen as inflammatory by other western nations, so a decidedly brave and contrarian attitude would be required by PSA to assisting Iran in its renewed plans for economic self-sufficiency and its overtly internalised economy planning.

This would vie against the American-led ‘international community’ sanctions - sanctions which PSa have upheld thus far with stoppage of CKD shipments - but without any direct US market presence and sales base as a concern, and few Isreali commercial links (unlike Renault-Nissan and the BetterPlace project) the company’s present weakness may mean that such a contrarian commercial stance is ultimately necessary as part oof its sustained development. Indeed then able to tap into Iran’s large population and so gain greater foothold the MENA markets as a pseudo non anti-Islamic multi-national, thereafter able to support sales ambitions across Indonesia, Malaysia etc. And vitally the much reduced value of the Iranian Rial would provide for a useful MENA export base for 301

Re-Capturing Europe -

Homeland France, Italy and Spain, as well as the remaining EU countries have proven historically critical to PSA, and will continue to do so into the future, even with ongoing BRIC and CIVETS expansion ambitions.

However, even with this fact, the Q1 2012 results showed a dire period. Sales declined by 20%, reflecting a similar loss of the overall car sector, and its market share slipped from 13.5% to 12.9%. Favourably the car market collapse was partly compensated by commercial vehicle sales which fell by ‘only’ 11%, PSA maintaining its lead with 21% market-share.

H1 2012 saw an overall YoY revenue loss of 5.1% giving E29.6bn, seeing a loss of E819m vs a E805m profit for the previous H1 2011 period. EPS was down to E-2.73 from a previous E3.55.

Yes, PSA is substantially reliant upon this territory, and some analysts / investors may seek to draw parallels between PSA today and the old GM within the USA before its collapse into Chapter 11 restructuring.

However, the two should not be confused.

Unlike GM and its high-profile but value-destroying Volt vehicle programme that promised a new future, PSA shows itself to have a strategic plan even if not made wholly explicit for commercial reasons. See between the lines and it is there. It also has an inherent re-structuring plan workable whilst operating as normally as possible: to retrench when and where necessary, to concentrate on core competencies (with technical bias) and fundamentally re-shape the business to suit the changed European and global ‘mega-city’ conditions of the 21st century.

An emissions consciousness in Europe and the much needed anti-air pollution policies of EM ‘mega-cities’ mean that shared socio-technical solutions will be inevitably sought.

This means that PSA is in fact in a fundamentally very strong long-term position, even if it has experienced constrained cash-flow conditions over recent years from volatile EU sales and the weight of internationalisation CapEx projects.

Showcased previously, even if witnessed little presently, is the progress made with eco-orientated vehicle solutions. Across the realms of:

1. emissions-cut diesel and petrol engines
2. impressive ‘lightweighting’ of monocoque structures
(new 208 actually 110kg mass reduction over outgoing [though heavy-spec’d] 207)
3. hybrid applications speciality for 4WD systems
(enabling a FWD vehicle platform to gain 4WD capability via a ‘bolt-on’ rear axle integrated electric motor
4. a new 3-cylinder engine as installed in new 208 & 301 (to follow elsewhere)
(matching other's 3 and 2 cylinder units)
5 Ahead in the key issue of diesel-hybrid appplications.

When taken altogether, the eco-leap PSA promises will directly benefit itself as a prime USP and may very well be doubly recouped via sales to its business partners; very probably including GM given its 7% stake.

2015 Rebound Plan –

CEO Varin’s turnaround vision was communicated in the 2015 Rebound Plan, seeking E1.5bn of cost savings and so FCF breakeven by end 2014. Gains sought are: €600m from reorganizing the French production - stoppage at Aulnay, adjustment at Rennes. E550m reduction of CapEx after the ramp-up volume in Russia, Latin America and China. Optimising product costs with GM synergies to give E350 million (half from purchasing synergies, half from development and production unit costs).

Changing Macro Conditions –

A little publicised fact, coming to light only recently, is that France has not substantially suffered from the previous downgrading of its sovereign bonds. The spread on France’s 10 year bond has actually narrowed considerably over the past 12 months, illustrating market confidence, its improved performance actually beating the demand-led yield fall of US Treasuries and German Bunds over the last year; which arguably may have hit rock bottom ‘inflation inversity’.

This then indicates that those previous barriers to national self-financing via the capital markets and any required access to ECB liquidity have been largely dismissed. On a national budget cash-flow basis, the country sits quite well; so presently able to fund its industrial and commercial ambitions.

Furthermore, and viewed as very important by investment-auto-motives, is that France’s close collaborator Switzerland has spent much of the last year printing money under the pretext of a deflationary stance to match the Euro. Yet with little need for those funds to be directed to national infrastructure projects or as social security provision as is the case in US or EU, investment-auto-motives believes that much of that newly created will have been acquired by Swiss investment banks. So ready to lend or take equity stakes in turnaround companies, very possibly including a ‘new future’ PSA, as a recognised leader of the eco automotive pack, both in terms of its vehicles and deployment of its systems R&D to others.

Conclusion -

The rapid damage caused first by the 2008 financial crisis and latterly by the 2010 sovereign debt crisis provided a double blow to the major industries of Europe. Yet those very same blows have also instigated a global-perspective reality check; especially for the likes of PSA, soon recognising the unsustainability of its old Eurocentric and critically undifferentiated products and service business model(s).

That set-off an industrial re-alignment effort across France, abetted by austerity measures, the likes of which has not been seen in the modern era.

Good potential exists for value creation at PSA and so share-price climb given the company’s underlying eco-tech strengths, its ability to shrink expensive French production (and ideally back-office functions), the opportunities to create powerful extended and new commercial alliances beyond GM (eg Toyota, BMW) to creating a deeper web of more B2B relations, which in turn providing for broader strategic possibilities; as well the desire to become a new-age flexible personal transport provider from scooters to ‘tread-lightly’ SUVs to vans.

And critically, the Euro vehicle downsizing trend is set to create the template for the world from here on in,

That broad and ambitious perspective was seen by the 80% over-subscription of its E1bn new share release earlier this year.

But whilst grand ambitions are abound, the present investor focus must be on those near-term structural achievements in capacity utilisation, divestments , project by project synergy savings, and the bottom line impact of the raft of new product launches. Launches that must see much improved supportive and meaningful advertising.

These alone will underpin credibility of a sustained transformation process, and so a broad range of cross functional operational targets should be set in stone and ideally communicated to Paris, Frankfurt, London and Wall Street through more detailed, operationally orientated, IR presentations.

The successful 2012 new-share issue and the opening of funding through the ECB and Switzerland may indicate that capital markets are now chasing industrial opportunity. But even with additional Euro and US QE and the likely increasing availability of private capital, that capital allocation will still need to be conservatively distributed and seen to 'sweat'.

Those who provide the best value creation opportunities, even if currently upon a ‘back-foot’’ position (such as PSA), must seek to do so through meaningful explanation of their big picture ‘destination’ and the milestone achievements of that journey.

Given the company's obvious tailwinds, if Peugeot SA does not pull-through its present circumstances and ultimately re-rise in a different shape, then (to badly re-appropriate Shakespeare) "Something is very rotten in the state of France".