Micro Level Trends – PSA & GM Alliance – The Alliance Mismatch...Yet Why The JV May 'Steel A March' on EU Auto-Sector Structural Reform

Industry and financial press discussion about the recent announcement of an alliance between PSA & GM has understandably been prolific.

investment-auto-motives' Previous Perspective -

Adding to the debate about conjectural value creation versus value destruction, on 28.02.2012 investment-auto-motives provided what it considers the end-game perspective between American and French interests. Specifically the hypothesis of GM seeking to 'return' the Chevrolet brand to France – the originator's own ancestaral homeland - so as to conquer those mainstream markets which the likes of Peugeot, Citroen & Renault (& FIAT) have ruled over decades. This done by purchasing and re-envigorating divested plants across France (as well as Italy and Spain) which provide for archetypical GM volume scale-led and US$ credit enabled empire building.


GM's 'Horizontal EU Expansion' Ambition -

Driven by the central issue of European production over-capacity and structural reform, that web-log of a few weeks ago sought to highlight how the very process of broad continental sector reform hastened by rapid need for corporate right-sizing amongst the national champion European VMs would provide the perfect storm for GM to re-invent itself inside Europe given its own much reduced 'balance sheet baggage' and the support of Federal Reserve enabled low cost liquidity exercises such as the various $2.3tr QE actions, $400bn Operation Twist and the recent initiation of 'Sterilised QE'.

That overview then gave the conjectural far-horizon view, and though aspects of the short-term were described, so providing the cautionary view on the alliance, it would serve to perhaps better explain why the synergies cited by PSA and GM are in reality far less tangible – especially so regards the key element of shared engineering platforms - than the corporate IR publicity machines headline grabbing rhetoric.


Exploiting The Trans-Atlantic Bourse -

The revelation of the cross-company dialogue which has been ongoing in earnest since early January is now well recognised by the investment community as seeking to create a 'good news' story with positive immediate and long-term effects on both company's respective share prices. A Franco-American hand-holding story especially pertinent in buoying stock prices given the corollary between the US and Europe by way of the NYSE-Euronext exchange - a conceivable case of pragmatic 'reverse pseudo financial engineering' – and the fact that the US is gaining economic traction whilst Europe is seemingly over the worst of its economic melt-down fears. Thus on the surface, a highly logical alliance given both company's European production woes, orchestrated as timed to macro-economic perfection; thus designed to impress Wall St, Paris & the City of London.


Managing Investor's Perceptions -

In reaction Volkwagen CEO Martin Winterkorn, who last week proclaimed that the alliance between GM & PSA essentially ratifies VW's synergy seeking in its own (brand differentiated) platform and systems sharing ethos.

However, whilst Winterkorn sought to proclaim VW's position as industry leader in this arena, there exists a very real difference between VW Group - as a unified entity that operates 100% holds over its divisional brands - and the new PSA-GM alliance. Whereas VW operates with singular control (as ingrained by Ferdinand Piech and seen with Porsche's eventual total absorption), the real-world dualistic demands of the PSA-GM alliance partners, driven by individual parent companies own strategic agendas, invariably means that it will not be able to act a decisively nor as deeply as the VW foe.

[NB Respective share-price and MarketCap valuation differences between VW and GM and PSA, highlights that point. As of 1.00pm GMT on 12.03.2012 : VW was E127.65 per ordinary share with MktCap of E59.39bn, GM was $25.62 and a MktCap of $40.11bn, PSA was E11.86 and MktCap of E2.69bn].


But Where is the Real GM-PSA Story? -

This is not to say that there is no synergistic operational overlap that can be leveraged for sizable 'behind the scenes' cost-down measures. Simply that investment-auto-motives believes that the ultimate outcome from the alliance may not provide the level of cost-saving that has been reported.- ie the overtly enormous $125bn purchasing pool first mentioned – given the lack of true synergies that can be captured which itself primarily results from the necessary need to defend core operations and primary product lines from intervention and thus interruption.

There undoubtedly are overlaps, the essential co-operative product stream to be highlighted where specific products can be targeted, but they in themselves will not provide the kind of 'supercharged' financial savings and income that the alliance message sought to propagate.

[NB. Beyond the alliance structure, GM and PSA are of course individual entities, and so the creation of the alliance hardly means that each is now “uninvestable”.

Instead, much depends upon both company's individual performance at cost and income levels. So, present and future proven progress in: regional markets (with +ve & -ve TIV trends), the divestment of redundant assets (as seen at both GM in its Chapter 11 procedure & recently at PSA), the strength of its technical strategy path which must marry regulatory demand with consumer needs and desires, the overall cost containment achievements spanning commodities and parts procurement, R&D , vehicle development & production out-sourcing , the 'externalities' impact of ongoing part-government ownership at GM and the dilution-effect of equity raising at PSA, etc etc etc. As ever, the grouped fundamentals, which must be grasped from the investor perspective to provide the ability to ascertain the 'sweet-spot' timing as to take either institutional, SWF, PE or private retail interests in these companies].

However, the central theme of this web-log is to convey the belief by investment-auto-motives that there is less innate 'investment power' within the new PSA-GM alliance than has been communicated by what are now mutually corroborative corporate PR machines.

[NB Exclamation by the popular car press states that critics say GME-PSA house has “ruinous dry rot, yet the pair are responding by building an extension”. This unfortunately over-emotionalises the necessary 'situational analysis' required].

Even so, it is only fair that the primary 'headlines' of the announcement be re-stated.

The JV Headlines -

- “Joint savings of $2 billion a year within five years”,
- “$125 billion purchasing power to be pooled”
- “Combined total of 12.5 million units”*

[NB * PSA annual build of 3.5m units / GM of 9.0m units].

Tim Zimmerman, Peugeot UK's Managing Director mentioned that “The terms of the alliance should be clear by the end of the year, and at the start we’ll make savings on commodities like steel. As the alliance progresses further, there’ll be savings on components, modules and platforms.” PSA's Director-General Frederic St Geours, a lead architect of the collaboration Alliance, has stated that alliance work started in earnest on 1st March, co-ordination via an 8-strong steering committee made up of four directors from both parties.

A main function of that committee will be to oversee what appears to be 4 matrix-type project teams which consist of multi-disciplinary departmental experts (ranging from procurement to engineering to production) which target a notionally identified 4 platform types:

1. B-segment platform(s)
2. D-segments platform(s)
3. Crossovers platform(s)
4. MPV platform(s).

The following very basically dissects the 'parts in the sum' to evaluate whether the 'sum of the parts' do indeed add up to 'more than the whole' as both alliance partners appear believe, and hope to convince investors.


Product Analysis -

The highlighting of 4 apparently very different vehicle types looks impressive, with seeming potential to accrue mass savings over what seem 4 distinct arenas; however, the reality is that since the emergence of 'module system sets' (pioneered by Ford & Toyota, Daimler, BMW and indeed PSA) the base 'platform' engineering of visually separate product lines is no longer wholly separate and distinct. Advanced IT systems and software have were developed to enable the creation of 'systems sets' which provide for far greater 'engineering exchange' in body structure, powertrain, chassis, electrical/electronic, trim & hardware across not only model variants, but across different models within a specific segment and importantly in recent years even across different segments.

[NB. Such engineering corroberation between A & B, B & C and C & D segment vehicles is much of the reason that basic vehicle dimensions have grown over the last few decades].

This basic explanation then demonstrates that increasingly MPV and Cross-Over engineering systems have merged, indeed Chevrolet's use of the separate terms to direct prospective customers viewing its European website toward the same product offerings highlight the trend of technical merge between these two once distinct classes. Moreover, the fact is that whilst there are smaller siblings of the same genre, the D-segment actually encompasses the majority of larger, space-functional MPVs and Cross-Overs, so a D-segment car (in its own sedan, coupe, wagon, body variants) will share much of the under-pinnings of a similarly foot-print sized MPV and Cross-Over.

Thus items 2, 3 & 4 listed by the alliance are in fact to a great extent the very same engineering platform base. But, any idea of a deeply ingrained platform share agreement which includes mutual R&D, engineering development and 'productionisation' appears hollow. Instead of heavy R&D and operational spend on such a platform, investment-auto-motives believes that PSA will simply in the medium term adopt and adapt (ie brand engineer) its partner's GM vehicles across the D-segment, thus effectually replacing the agreement with Mitsubishi and relieving itself of costly large car responsibilities.

[NB Since the demise of the Peugeot 505, history has proven it economically untenable for PSA to create its own platform in this field, though its does (at a reducing rate of loss) so as to appear a full-line producer (thanks to increased module share 'into' the 508 and to French government and French fleet sales].

However, whilst there may seem potential for far-horizon collaboration for a D-segment (mid-size in US) sedan and its variants, the fact that the majority of sales for this sized car are in North America and China – both GM strongholds – thus give GM the scale advantage, so the engineering eminance and so disadvantages PSA. Importantly, GM must necessarily maintain near total control over this platform to ensure its core American model Malibu can compete directly against the Ford Fusion (& Taurus), Honda Accord, Toyota Camry and now Hyundai Sonata & Kia Optima on both production cost vehicle attributes. Thus, the ability for PSA to notionally co-develop and so influence its base engineering for Peugeot, Citroen and DS attributes looks highly unlikely, more so since the 8th generation Malibu will be introduced in 2013, making it virtually impossible for PSA to 'mould' the car to its requirements, thus would either be forced to simply 'badge engineer' or to undertake an ill-advised 'SAAB-esque' approach.

[NB The SAAB experience under GM being that it had to add the high cost of a 'DNA' re-design programme to the original 'percentagised' development cost of the base car programme. Both these CapEx and R&D expenditures then required to be ammortised over dwindling sales volumes].

As for the mutual development of a B-segment platform, as investment-auto-motives stated in its previous essay, this segment has now become key to all volume manufacturers. The the case given that this segment has in recent decades it has held the largest portion of global industry TIV, with that trend set to grow because of continued economic expansion in 'BRIC' & 'Next 11' EM markets have a proclivity for compact cars, and the fact that the 'developed' 'triad markets (Europe, N.America and Japan) continue to 'down-size' in car size due to reduced spending power and an ageing population which seeks smaller car running costs and manouvrability.

As a result, it seems incomprehensible that any volume manufacturers - especially GM and PSA given their growth ambitions – would seek to share their individual control over such a critical issues as product, strategic and income destinies.

It was stated outright by both alliance partners that exploration of the A-segment was not included in the alliance, this it is assumed because of the in-house capability at GM which stems from its Korean operations, and the fact that PSA will very probably seek to retain commercial JV links with Toyota for future generations of Aygo/107/C1.

And it was equally stated that the C-segment would not be mutually explored because of PSA's recent introduction of the new 408 which will have approximately an 8 year lifespan, thus not to be replaced until 2018-19.

Thus all the conventional car arenas offer little collaborative space.


A Focus on Commercial Vehicles -

The only alternative arena is commercial vehicles, ie Vans and their myriad of model and variant types. Here, investment-auto-motives believes, the present JV experience of Chrysler-Daimler (ie not Daimler-Chrysler alliance of old) has had an important affect on GM & PSA executives.

Chrysler has ostensibly 'off-shored' a major part of its US commercial vehicle division by 're-badging' (and critically 'de-costing') Mercedes-Benz van products as its own under the Dodge brand.

It is suspected by investment-auto-motives that GM will undertake a similar strategy within Europe, done so by switching partners from Renault (from which its uses Master and Trafic models) to PSA, so as to fill capacity at its Luton van production centre in Luton, UK. Given that PSA already relies upon its FIAT alliance to produce its 'Eurovans' in both 'Sevel Sud' (Italy) and 'Sevel Nord' (France), the situation in turn generates conjecture that GM will join this duo as a third partner.


Steeling The Far Reach Competitive March -

Given the higher portion of metal content of box-vans – on a parts count and systems-value basis - this PSA-FIAT-GM joint venture could then better impose its will for raw materials discounting from global steel suppliers; an arena which Philippe Varin of course knows intimately.


Conclusion & Hypothesis -

To summarise, from the all important product perspective there appears little immediate and indeed medium-term scope for major cost-cutting exercises beyond that offered by the creation of a new commercial vehicles triumvirate group.

However, that group and associated conjoined commercial enterprise may seek to lay the foundations for broader materials procurement leverage on behalf of the passenger cars divisions within PSA and GM.

This then suggests the possibility that the PSA-FIAT-GM commercial vehicles group latterly spin-off a raw materials buying entity – essentially an intermediate broker - which could perhaps better serve the industrial bargaining needs of PSA & GM, and indeed become a co-ordinator for a much enlarged European Chevrolet (as described) aswell as other European based indigenous producers (eg Renault, VW, BMW, Daimler) aswell as present Asian 'transplant' producers (eg Hyundai-Kia) and possibly Chinese manufacturers (eg Geely, SAIC, BYD, Great Wall).

Given the lack of deep product and product programme rational behind the GM-PSA alliance, there must exist other compelling reasoning.

So the possibility may well exist that whilst GM expands horizontally further into Europe via PSA's production base, PSA itself could as well as climbing the value-ladder with the 'transport solution' ideology that is 'Mu', also seek to descend the value-ladder into the world of low-value metals, but as a broker not direct supplier, then possibly broadening to brokering higher value metals and materials which are becoming ever more critical to vehicle structures to achieve low CO2 targets by 2020 and 2050.

Thus, the rational of the GM-PSA alliance could then be far deeper than anyone imagined, with far greater consequences for structural reform of European car-making.

The rightly self-congratulatory Volkswagen (sat on its net liquidity cash cushion of E17bn) - like those at BMW & Daimler - might wish to consider more deeply the far-horizon consequences this conjectural hypothesis holds.

But for VM competitors and the myriad of investor types alike, the synergies of the GM-PSA alliance itself offers little immediate excitement. Instead, it seems a necessary case of reading between the lines to understand the true logic, and here the hypothetical influence appears set on the 'invisible' far horizon. That of necessary corporate structural change 'horizontally' and 'vertically' that can both serve and gain reward from the sector's own evolution as determined by a changed EU market demand dynamics and the broader competitive environment.

Companies Focus – The Western 8 : PSA Peugeot-Citroen – Losing the EU Reactivity in its Hub & Spoke Business Model

PSA, although larger than its Gallic peer Renault, beyond its French homeland has always given the impression of a somewhat smaller entity. A persona in no part due to its cleaving of production & sales figures between its dual Peugeot & Citroen brands, its smaller penetration within its semi-global footprint with tied to ex-colonial regions, and the fact that throughout the 20th century the Peugeot family owners – now holding 30.3% - and senior management have seemingly purposefully chosen to stand back from the limelight, with an innate mantra of “products not personalities”, best shown by Pierre Peugeot's role model behavior.

Given the 15th century roots and impressive but low key multi-sector growth throughout the industrialisation era, the Peugeot family have understandably long held almost baronial ownership, influence and autonomy as most precious; the redrawing of the familial lion passant in January 2010 emphasising the point.

Thus it is perhaps no surprise why the PSA board made up of, and led by, family members have typically appointed CEOs with deep industrial understanding but typically from non-Auto companies – Folz from aluminium & electronics, Streiff from aerospace and latterly Philippe Varin from steel. Such appointments seemingly intend for leverage of a CEO's innate knowledge and access of complimentary industrial sectors (ie 'input' or 'development'); whilst not exposing the family to possibility that a CEO will 'company hop' across the auto-sector, and so possibly engendering (corporate secrecy) betrayal.

As is well established, in almost ironic reflection of the separate Peugeot bicycle company, PSA Peugeot Citroen (still integrally holding the scooter division) operates a 'Hub & Spoke' business formula. One in which a theoretically cost-conscious, omnipotent central HQ deploys its evolved and strategically aligned small car core-competence whilst also: buying-in required fringe products/technologies, selling-on proprietary technology to 3rd parties and forming strategic R&D / manufacturing / retail alliances.

That philosophy has been officially transposed into the PSA production System, an approach that maximises scale efficiencies within, and externally to other parties with over-lapping strategic goals. In physical terms it means 3 internal PSA platforms, one of which is to be extended as a core enabler in 2012 and beyond; aswell as 2 platforms deals with FIAT on LCVs & MPVs, 1 platform deal with Toyota for the A city car segment, 1 platform deal with Mitsubishi for SUV and 1 with FIAT & TOFAS for LCVs. And in Q1 it renewed its agreement to develop and manufactured a shared 4 cylinder engine with BMW AG.

In an age of unforeseen 'Black Swans' creating consequential global economic and political turbulence, the family no doubt see themselves as proven right to protect PSA's innately flexible business model, yet given its comparative smaller industrial weight it must perhaps also act more quickly and nimbly than its larger peers to identify and secure areas of advantage with other (typically EM located) parties beyond its primary sphere and influence.

In doing so given that PSA is a very different beast to its archetype multi-national peers, Varin and his lieutenants must proffer different raison d'etres to compose alternative alliance virtues, the diesel technology lead the attraction for the industry at large and ability to sell modern or near-modern product to the national car companies of EM nations as part of their own economic development plans. These then have been to the 2 external alliance hooks to date, whilst internal alliance hooks have provided for the 'plugging' of PSA product portfolio gaps (eg Mitsubishi Outlander), model specific alliance manufacturing to defray plant investment risk (eg Toyota Aygo) and 'PSA brand advancement' initiatives (eg enabled by Mitusibishi iMEV electric vehicle).


Q1 2010 Performance -
Group Revenue increased by 27.5% from E10.97bn to E14bn compared to Q109; so reflecting the general upward trend of a rising tide of the time. Group worldwide sales for the YoY period increased to 914,000 units.

The Autos section individually posted a 22.4% increase YoY to E10.619bn, up from E8.678bn in the preceding year. As is evident, Q1 still enjoyed the tailwinds of various national scrappage schemes. Being well positioned PSA gained share in that period, cars & LCVs up from 13.5% and ending at 14.6%. Greatest gain were was in Italy, up 1.8% to take 11.6% of the local market.

Having experienced an early boost, executives previously forecast that the EU market will shrink YoY by 9% given the reduction in broadscale Keynesian economic policy and adoption of a far more Monetarist fiscal tightening approach.

Faurecia:
This subsidiary which manufactures various vehicle module systems sets enjoyed a vaulting 59.5% rise in Q1 Revenues, reaching E3.2bn from E2.0bn in the preceding year.

Gefco:
The subsidiary logistics company saw a 27% rise in Revenues as its Q1 figures reached E842m, up from E664m.

PSA Banque:
The captive financial arm of the group saw marginal decline in Q1, Revenues down by -1.1%

However, the company did not release any profit or loss figures in Q1, a fact which investment-auto-motives' believes was sanctioned by the Board so that investors and the French government would not witness a 'see-sawing' of corporate income fortunes as the tailwind of the EU scrappage schemes came to an abrupt halt. Thus done in order to manage expectations and present a smoother income distribution picture over H1, H2 and FY2010.


H1 2010 Performance -
Global auto markets sales increased by 13%, led by China at 27% and Latin America at 11%, whilst European sales was very variable, France up 6%, UK up 19%, Spain up 38%, Germany down -27%, CEEC down -13%.

H1 sales figures reached a new high of 1,856,000 units, so up 16.9% if CKD figures are incorporated. Of this fully assembled vehicles represent 1,618,000 so 16.8%, and CKD kits represent 237,000 (a rise of 18% YoY, mostly from Peugeot). European sales rose 1% to 14.6% market share when including for EU, EFTA & Croatian figures. PSA's reliance on Europe declined slightly, with non-European regions accounting for 36% versus 34% a year previously. PSA maintained its lead in small & compact LCVs, yet in a sector that grew 9.4% YoY only gained 0.4% market share to 22.4%.

Yet, at a time when PSA should have been 'mopping-up' towards the latter-end of the European 'perfect storm', the 1% increase is (as expected) disappointing. The levels of artificially generated consumer demand growth for low CO2, affordable cars (PSA's hallmark) may not be seen again, even if a double dip recession does take hold. Similarly, the rising-tide in LCV growth has only seen a near equivalence maintained, when PSA should have been in the LCV driving seat.

Thus investment-auto-motives believes that the opportunity that arose was under-played, and partially mismanaged, probably as a result of overt constriction on NPD budgets as part of group-wide cost-saving efforts which kept the company effectively treading water, and relying on consumer purchase discounts and incentives necessary to shift factory and dealer inventory, keeping cars sales buoyant, which enabled it to reach its 'record' sales figures. Figures achieved probably at the cost of per unit profitability margins.

For Citroen, the unfortunate late introduction of new C3 in Q409 meant that the division was bereft of product, it will have been 'pushing old product' such as C1 and old C3, but critically had (and has) no C2 model. C3 Picasso mini-MPV was perhaps its only tenable model to befit the scrappage scheme incentives, but the lack of attractive siblings demonstrated Citroen's effectual absence from the dynamic market.

For Peugeot, the aged 107 offers little attraction even if an apt vehicle, whilst a mid-2009 face-lifted on the 3 year old 207 was too subtle to be of commercial effectiveness, thus simply kept it in the running in the middle of the pack, as opposed to its 'rightful' position of 'front & centre'.


Strategic -

Outside of homeland France PSA's dual identities, both hinder and help the group at large. Unlike other OEM's typical single marque dealerships, its history of dual brand dealerships has muddled the market offering. The innate PSA experience at the critical purchase decision point has been mixed; one of almost paradox given each brand's 'dueling for buyer attention' created by the price-point and target market differentiation. [NB Citroen pitched as affordable to a family market, whilst Peugeot pitched higher, to more sporty singletons and couples]. That mixed message of single sire dealerships made even more opaque with the introduction of Citroen's DS models, which reach into Peugeot territory.

Of course the efficiency and market(s) reach rational of running dual-brand dealerships for the corporation and dealers alike is of course beyond the historical picture still compelling, especially so in these financially constrained times that require the sweating of a locational asset. Recognising this corporate schizophrenia as an integral issue driving the need for a brands identity update – relative to brand perception & experience - PSA had Citroen and Peugeot logos redrawn. (Moreover, new corporate messages were generated: Citroen as “Creative Technologie” & Peugeot as “Motion & Emotion). Both now depicted in the polished metal badge that has become the auto-sector's homogenous requirement. This then negates the old colour clash between Peugeot Blue and Citroen Red on all corporate identity items ranging from stationary to advertising to dealership facades and provides a level of unity between the brands and throughout each's marketing communications palette.

However, whilst undoubtedly good for the corporation and dealers in the mid-term , the change forces a sizable overhead cost to dealers, since good corporate identity change programmes span a raft of areas well beyond the door-top signage of a forecourt, including full exterior, full interior and the use of corporate prescribed desks, chairs, picture frames, etc etc to ensure all dealer convey the same corporate persona. Usually prescribed to its 3rd party agents in the early phase of an economic recession, those agents not in booming EM regions will be resisting change, especially as they see their monthly sales figures reduce as the scrappage effect fades.

The consequences of this will probably for a period further muddle the Peugeot-Citroen identity on the high street and in retail parks across the UK, Germany, Italy and perhaps most so in France, as a renewed corporate identity roll-out creates a patchwork of dealership facades: the new 'chrome' vs old 'blue & red', sites which further erodes the perceptional integrity of the business. To avoid this highly probable outcome PSA will need to be both firm in its implementation, yet be flexible enough to maintain good dealer relations – so necessary during this time of economic flux. A partial subsidy of the roll-out programme is the typical answer (with latter-day claw back of the sum from dealer margins), yet whilst such a solution does ensure quick adoption, it does create a drag on near term quarterly profits.

The corporate R&D strategy of course spans the 5 prime systems areas of: a) structure, b) powertrain, c) chassis, d) electrical & electronics and e) trim & hardware. And in recognition of its own strength and competitor strengths PSA maintains a focus on Powertrain, its future-view of which includes high-efficiency diesels, dual-role hybrid technology which sees the electric motor fitted as a complementary item added in almost a 'bolt-on' manner to the the secondary axle, and the seeming perennial slow maturation of EVs.

PSA's diesel capability has long been recognised by the public since the 404 model with Peugeot trying to maintain that reality and impression via motorsport such as Le Mans (with Audi diesels literally close-by), the WRC and other privateer team links with various endurance racing..

Importantly, Q1 saw the announcement of a 3 cylinder turbo engine being developed. With a 175m budget this looks like an adaption of a 4 cylinder architecture as opposed to what would be a more expensive new engine family.

With regard to hybrid tech strategy, PSA is following both conventional and unconventional routes, the latter as seen with the introduction of the 3008HYbrid4, the intention is to use exploit low-cost applications methods which instead of being intrinsically built-into the prime powertrain of the car (as with Prius or latter diesel 308Hy) or indeed optionally mated to the gearbox (as with FIAT), is instead a very separate entity which requires as least engineering interference with the prime mover unit as possible, and instead develops a structural package protection policy affecting small sections of the platform rear to house a rear axle electric motor and battery space.

[NB This was has been the conventional approach for hybrids throughout their 20th century development - eradicating the problems experienced from the hub-driven Lohner-Porsche yet maintaining its dual systems simplicity – and most prominent in military applications to provide both short-term silent running and optional 4WD].

Thus through Bosche co-developed systems, PSA though later to market with hybrids is theoretically well placed to in time 'steal the march' over less frugal petro-electric hybrid systems offered by others.

At the geographic level the BRIC regions and other 'secured' EM nations are of course a major focus for PSA, as for all western VMs seeking future growth.

China:
China has obviously offered growth in recent years as its economy flourished, and even with the slight slowdown seen in recent months, will continue to do so given PSA's long established market presence. H1 2010 saw a 49% sales increase YoY.

Its operational presence has been buoyed by the fact that a new JV agreement is to be signed with Changan Motor which provides a second manufacturing avenue given the long established JV with Dong Feng (DPCA) now running with available capacity of 450k pa via 2 plants and another Powertrain plant with 640k pa engine capacity and 375k pa gearboxes. This production 'homeland' formed a base from which PSA was able to build Chinese presence for Faurecia, GEFCO, PSA Banque (market entry via Bank of China), and latterly R&D capabilities (titled the China Tech Centre) in Caohejing, Shanghai, which both encourages local supply-chain strength and modifies vehicles to meet national consumer expectations. This capability works reciprocally with the Tongji University's Institute of Automotive Studies, the recent fruition of which was the April debut of the Metropolis concept – the first notionally Chinese concept car developed. And recently an exhibition partner for the French stand at the Shanghai World Expo.

[NB. Present press reported regards the evolving 'remoteness' of PRC attitudes to foreign company presence may or may not be being over-stated. Yet it seems that given long recognised Auto Policy which necessitates the consolidation of the domestic auto-industry that PRC officials will implicitly “balance” the interest levels of foreign interest companies. To this end, investment-auto-motives believes that given its effective role as an early entrenched sector development 'agent', PSA will have the innate advantage over its peer Renault which may increasingly need to rely upon its Nissan standing in the country. Hence although sector shrinkage will continue to proceed, PSA is not in danger of being marginalised given its deep involvement to date along with of course VW & GM].

Presently China accounts for 14% of PSA Autos sales, up from 10% in 2009, which highlights the disjuncture between the 2 markets over the period.

However, historically ranked as the 3rd foreign brand, it can be argued that Citroen is more susceptible to the intrusion of other non-Chinese marques from Japan and S.Korea aswell as China's own championing brands such as Geely, BYD, Great Wall etc. Hence the introduction of Peugeot 5 yeas ago. In obvious contrast to the near static product management of ZX in its former years, PSA must demonstrate a near constant model evolution policy that sees low cost but truly noticeable aesthetic modification every 18 months or so; very much aligned to the USA's 1950s new model year ethos of 'planned obsolescence' creating an ever-changing surface impression to avidly promiscuous consumers for what are in effect long serving, highly amortised platforms and architectures.

[NB investment-auto-motives proffers that in doing so, an additional income stream could be obtained from a newly created separate after-sales unit, with the remit of offering to (same shape) older model buyers, cosmetic update packs which imitate the features on previous model years, and negates the oft seen poor efforts of used car personalisation that can damage brand perception. This thereby maintains a constant design lead yet allows for a sizable after-sales opportunity in parts and service to perpetuate demand for new and near new vehicles in what is possibly the world's harshest auto-retail environment].

Riding on the back of Citroen standing and offering something akin to Euro-sportiness, the Chinese sales of Peugeot cars have climbed ever upward, reaching 410k units in 2009

Russia:
In Russia, Moscow, St Petersberg and regional surrounds experienced a -7.6 % YoY sales decrease for H1 2010.

Assembled vehicles from the (Mitsubishi JV) Kaluga facility (110 miles south of Moscow) came on stream in April, though the initial plan of 75k units pa may be reduced. The E470m plant was designed with an annual capacity of 150k units which was intended to serve a 100k 2010 Russian sales ambition generated in late 2007, but a massively declined car market has of course undermined that target.

[NB the original 150k capacity has been officially reduced to 125k, very probably to demonstrate better plant utilisation rates when the factory ramps up production].

Moreover it reportedly caused a massive over-stock of vehicle inventory, which has sat as a virtually unattended glut on the runways of a fringe airport near St Petersberg for a year. Conjecture presents that given the inability to properly secure these sites that the criminal fraternity will have been tempted to steal whole vehicles and parts for black-market export to the Balkans, Greece, Turkey & CIS.

Mercosaur:
Whilst Latin America generally saw sales plummet in 2009, Brazil and surrounds saw an 11% YoY increase for H1 2010, so theoretically aiding the goal of reaching 500k units pa in the mid-term.
Q1 saw both Brazil and Argentina lift 17% or so, PSA beating the market trend with a 20% rise.

PSA currently holds 5.3% Mercosaur market share, something it intends to buoy with the capacity exapansion of its Porto Real plant in Brazil and Palomar facility in Argentina, the cost bases of which to be assisted by the establishment of a regional Procurement School.

The ambition is to become a top 4 producer in Brazil, so displacing either FIAT, VW, GM or Ford,: all of which have appreciably higher regional share. The PSA Board views a #1 position in the Argentinian market as the prime stepping stone. However, having seen Argentinian gains of 26% in 2007, 2% in 2008 and -22% in 2009, even in a market up 20% so far this year (peaking at 37% in March) the performance of PSA is uncertain given its lower ranked position, unless its new Hoggar car derived pick-up manages to steal hearts and minds.

India:
The Asian sub-continent has been a frustrating arena for PSA, with previous attempt(s) flailing. However in the last year PSA re-affirms its intent not to miss out on such present day lost sales, and the obvious large future potential. Chennai – the small car manufacturing & export hub of the country – has once again been notionally nominated as an ideal location, but for the production of mid-sized cars: presumably in the Logan mould, so following Renault's entry strategy (beyond its own Bajaj JV small car intent).

This is one where western OEMs avoid head-on small car competition with the likes of Maruti-Suzuki or TATA, and instead push the sale of affordable compact saloons and hatch-backs, thus following the path of Ford and others.

Yet it also follows a similar effort over a decade ago with the 309 in partnership with local producers Premier Motor. This stumbled due to an overlap of various issues, including immature market, low sales and worker demands raising per unit labour costs, and claimed low support of the service network by TVS (Chennai) and others. Moreover Premier Motor also undertook a renewed agreement with FIAT to assemble the cheaper Uno which undercut the 309. The outcome for PSA was to see the Peugeot name spotlighted in consumer issues press, somewhat staining its reputation, having pulled out in 2001 has waited a decade for a re-entry attempt.

[NB Given the present heavily declined position of Hindustan Motor – losing R-3326.37 Lahk in
Q1 2010 – the company aswell as rationalising operations and expanding Mitsubishi licensed vehicles may well be seeking additional JV projects or full alliances. This will not have been unnoticed by PSA executives – as indeed that of other western VMs – and investment-auto-motives expects that the basis of a mutual agreement between PSA and Hindustan Motor will have been explored, possibly engaging latter-day 3-way talks between the parties given the PSA-Mitsubishi alliance link already in place, in a near copy+ of the Russian Kaluga agreement].

Having previously conducted feasibility studies PSA believes it must operate at above the 5 Lahk mark to both separate itself from the centre of the mass market, presenting a price differential on the local value ladder, between a lower set Peugeot and higher set Citroen. R-introduction set for mid 2011.


Viewing PSA concept cars, last year's Peugeot BB1 city-car with unorthodox 'twin scooter seating' arrangement was really an exercise to publicly demonstrate the company's attention regards small car products such as Smart ForTwo, BMW's upcoming MegaCity and France's own established Axiam Mega (which acquired the UK's NICE Car Co). The recent SR1 simply sets-out the future styling tone, which see Peugeot a much needed return to handsome conservatism after what as been a period of deliberately provocative unbalanced proportions (esp front vs rear), general form and oversized trim and hardware such as grill and lamps, The SR1 heralds back to the much lauded Pininfarina designed 'clean' 'thin-lamp' 406 coupe, and in doing so should convey improved product qualities and quality that will help maintain pricing levels.

For Citroen, following the 2CV inspired Revolte from last year, the GQbyCitroen concept which allied the division with GQ magazine appears little more than a March/April 2010 marketing initiative, exploiting a computer rendered concept car as an 'Advertorial' truing to reach a higher disposable income target market audience which would not ordinarily consider Citroen. Physically real – even if really another PR exercise is the Survolt race EV, premiered at Le Mans presently.
And as previously stated PSA China illustrated the Metropolis concept, still bound to a computer screen and reflecting SR1 cues, but essentially declaring the maturation of its local self and in a broader sense China's own improving R&D skills.

As for the future of the DS line, the 'High-Rider' offers a second DS model derived from the 3008 Hybrid4 platform, offering instead a 3dr coupe package

Given the creation of a more upscale DS line, industry observers have been questioning about the creation of a low-level line to compete against Renault's Dacia in specific EM regions. Jean-Marc Gales (Head of Peugeot-Citroen brands) has not outwardly refuted the idea and given the in-roads Dacia has made in both EM and latterly 'advanced' areas, it must be top of mind even if not explicitly sat on the Board agenda. Gale adds fuel to the conjectural fire by stating that such an initiative would be (obviously) not centred on the EU, presumably instead driving demand from near-east stronghold countries and India.

Mu by Peugeot:
Mu was previously launched to demonstrate PSA's commitment to the 21st century ideology of 'a la carte' personal mobility, offering a one-stop-shop service for the individual, couples and families to order and experience a selection of 'mood & mode' appropriate, low carbon footprint travel solutions. The service ranges from bicycles to scooters to cars, MPVs and vans to in due course EVs.

Introduced in Paris, it is now available from Peugeot owned dealers in Berlin, London, Madrid, Brussels and Milan, due for extension into other 2nd tier cities in these countries aswell as the Netherlands and Portugal.

It has won Automotive News' LEADER award in the distribution category, and with over 200,000 website hits has spawned public interest from press stories, yet exactly how many take up the service remains to be seen. At the very least even if ultimately unsuccessful as a transport rental model operated by PSA dealers the initiative does allow PSA to claim corporate social responsibility bragging rights aswell as increasing footfall into corporate owned dealerships, a percentage of which will be converted to conventional vehicle sales.

However, ultimately the roll-out of Mu should be applauded given the sweating of the PSA asset-base in terms of dealer locations and broad product portfolio, as long as undertaken as a constrained, high impact initiative that is not expected to perform overnight, but instead gains ground across Europe's metro-centres year after year. It must then have a 5-10 year commitment with ideally separate and detailed cost-centre financial reporting.

Given the auto-sectors long-held desire to re-orientate aspects of its business model to reach over into the typically warmer investment waters of 'hi-tech consumerism', PSA with investment banker assistance, will probably be moulding Mu as necessary to attract PE 'eco-scheme' interests prior to an ideally envisaged long-term IPO; the process of which allows PSA to enter untapped global metropolitan areas as a precursor to growing PSA in low exposure and uncharted regions.

Thus the role of the allied 'Peugeot City' sites (seen first at Rue de Chateudun, Paris in March) is to set a new alternative retailing tone. It is set out with 4 distinct zones: 'Lab' (visual vehicle personal spec facility via touch-screen), 'Novelty' (for brand news updates), 'Urbanilty' (for communicating Peugeot's mobility philosophy ie prompting bicycle and scooter use) and 'Advice' which acts as a conventional purchase and finance agreement desk). Latter locations include Warsaw & Riyadh.

[NB investment-auto-motives conjects that PSA will indeed introduce a second sub-brand (akin to DS) which will compete against Dacia, Skoda and others in the entry-level section of segments. And given the manner in which DS sits above, so “CV” appears to be a powerful nomenclature to sit below the 2 primary Citroen and Peugeot brands].


Operational -
Cars:
The beginning of the year started with a tinge of dismay as PSA announced the recall of 100,000 107 & C1 cars that were deemed to have inherent problems given their twin manufacture with the Toyota Aygo in the Czech republic.

Of the recent & soon to be introduced new models: 5008, DS3 Racing and RCZ, although they do fill the product cadence pipeline, they do not in themselves significantly lift vehicle mix and so income contribution as typically new conventional mainstream product would. RCZ is a halo product to lift the image of Peugeot and although seemingly well conceived from a 'parts-bin' view, so limiting project investment and time to market, and per unit margin, its limited numbers offer a small financial contribution. DS3 Racing, though in greater numbers is derived from the same raison d'etre, indeed it seems the ethos of the sub-brand itself. Whilst sales will be greater than RCZ as a cheaper more practical car, its volume and reduced margins still adds relatively little contribution at this critical time.

The 5008 is a slightly different beast, as a compact 'high-ride' CUV, serving as the 7 seat variant to its 3008 sibling introduced last year; that earlier core variant due to take much of the PSA Lion's share in this segment. Given its 308 platform roots and the development of the vehicle type from MPV-SUV-hatchback roots, the 3008/5008 can be regarded as 'fringe mainstream' given that monospaces account for 19.4% of sales in France, 14.3% in Germany, 13.5% in Span, 13.1% in Italy and 11.7% in the UK. Thus whilst the physically longer 5008 may add additional sales and possibly good unit margins (depending on accounting methods), it will be the 3008 which serves well throughout the remainder of 2010.

[As described in previously posted PSA comment, the DS sub-brand – intended as a Mini competitor – is only really a compelling proposition to French buyers given the sub-brand's relevance to the French popular consciousness (and even then only really to older people such as the 'grey set)' who seek something petite, Francaise et avec 'la difference'; thus not a product platform (in its current guise) for Pan- European or worldwide product success].

The new 408 sedan and variants is launched worldwide in H2. In a change from the historical norm of a separate model line, in a bid to harmonise and scale-up platform efficiencies, the new car is effectively an (rear overhang) extended 308 given a boot/trunk and saloon profile. This marked change, from a poor-performing low level pseudo-exec EU-centric car, better suits the compact sedan demands of EM regions.

Citroen C5 is also additionally launched in China, whilst Latin America gains the 408, C3 Aircross and Hoggar (208 pick-up)

To maintain public profile PSA ran two new RCZ coupes at the Nurburgring 24 Hour race in May, taking first & second its class (sub 2.0L diesel); one of the cars driven by Jean-Phillipe Peugeot – Vice Chairman of the Supervisory Board. It was of course both a pre-cursor to the LMP event at Le Mans and a celebration of Peugeot's 200 years since official formation in 1810, together an effort to raise Peugeot credibility amongst the dominant 'sporting class' Germans.

And lastly, to demonstrate its self-styled leadership role in CO2 friendly cars, PSA states that it will:
by 2010-end introduce 3 models that reach 99g/km or less (207*, C3*, DS3* – Airdream etc spec. engineered) [NB* the substantially higher list prices of these type of eco cars from all manufacturers, to cover project engineering costs and set an eco-premium precedent)
at 2010-end introduce an EV
in 2011 introduce diesel hybrid variants of 3008 and DS5
in 2012 introduce a plug-in 3008 (rated at 50g/km)

Faurecia:
Though Q1 was relatively quite, company ambitions regards Chinese expansion were realised in June and July, having seen its sales double over the last year thanks to continued business relations and a prior rebound in the domestic market (before the recent slip).

June saw it take an 18.75% stake in Xuyang Group of Changchun, Jilin Province.. This company owned by the local municipality supplies to FAW (including FAW-VW). In detail, the various systems divisions are to be split as:
Seating : 60% Faurecia vs 40% Xuyang
Interiors: as above
Accoustics & Interior Trim: 40% Faurecia vs 60% Xuyang

And on 2nd July it finalised a cooperation agreement with Geely and Limin for exterior and interior systems for all of Geely's brands manufactured out of 5 new plants currently under construction. These include 'Emgrand', 'Englon' (the London Taxi JV) & 'Gleagle'

GEFCO:
Little operational news has been announced from GEFCO HQ regards performance to date, however beyond winning an industry award, the downside has been a notice from the (soon defunct) FSA to its UK division.

Dated 26th April 2010 it states that GEFCO – amongst others - had not supplied details of their Retail Mediation Activities Returns (RMAR's) within the required time period.

Whilst the revocation of FSA approval may be seen as simply the regulatory body trying to show its teeth before its disbandment, it still highlights the poor business practices and possibly business culture of GEFCO UK Ltd, something GEFCO HQ and PSA HQ should take seriously if it is to demonstrate itself as a truly untinged entity when seeking credit market related activities in various regions.

PSA Banque:
Q1 saw the division access a E1.8bn from capital markets as like many CFOs it sought to exercise beneficial conditions given possible credit contraction possibilities on the horizon.

As with all auto-producers, deployment and exploitation of captive finance houses have been recognised as key to retaining access to wholesale credit markets. As a result of previous reliance on a few key western locations – as has been the historical norm – the credit crunch and EU sovereign debt problems have forced producers to set-up far more market localised in-house financing operations, acting as the intermediary between less problematic local wholesale credit markets and the pent-up potential demand of dealers and consumers. Thus reaching further into BRIC+ territories has been a primary management focus over the last year.

In this vein in January PSA has announced its regional licence completion for PSA Banque RUS in Russia, taking over AIG's previous operations and taking a 98% stake, a necessary move given PSA's small but evolving market share and availability of PSA product from the local assembly facility in Kaluga.


Financials -
Unfortunately PSA transparency in this field has become ever more opaque, which unfortunately gives the impression of budget allocation struggles having absorbed the 'life-saving' E3bn soft-loan last year/

The FY2009 report tried to balance an overall dark picture of (reduced) debt (to E1,993m from E2,906m) and operating losses (of E689m) with the upbeat highlight of a positive FCF (at E809m).

Such a bias to demonstrating healthy liquidity has of course been normal modus operandi for most VMs, well recognising that organisational and balance sheet re-dress to demonstrate the availability of working capital was viewed as key – even if the other accounting fundamentals flailed. Unfortunately for PSA the balance sheet – from an officially interpreted distance - appears more stretched than its peers, which whilst also suffering aren't quite as much, and typically have greater strategic and operational strength behind them.

To add further liquidity a E500m 5 year corporate bond issuance was offered, with as a counter-measure against debt over-exposure and so credit-rating mark-down, a partial bond buy-back initiated to the value of E244,950,000 for previous 10 year bonds issued in 2001. Theoretically given the end of life timing, with few if any coupon payments remaining, they would have been bought-back at near par value, and seems a case of recycling funds to sustain fixed income markets standing.


Conclusion -
Just as the hub & spoke design of a bicycle wheel is able to absorb and reflect external shocks, with simple change of spokes as necessary, so the Peugeot family have exploited such a flexible organisational format to maintain control and quickly access areas of competitive advantage & competitive equalisation.

However, the creation the organisational structure and the ability to exploit the advantages it affords very much depends upon fully understanding the dynamics of external forces. PSA's ability over the last 20 years to receive pertinent market intelligence, formulate required action and and execute has been part of its innate being that allows it to maintain its level of independence and supposed flexibility.

But the inability to react harmoniously to recent 'perfect storm' events highlights what could be evolving invisible stresses from within, and the very real need to make speedy progress in the Group Performance Plan that seeks to re-balance the apparent massive inefficiencies that have crept in over the last 5-7 years.

Investment-auto-motives external observation presents a case where PSA has partially suffocated its prime European offering so as to strengthen RoW operational capabilities and offerings in its 'holy grail' EM regions. A pertinent internal geo-political case of being sat between 'a rock and a hard place', and possibly fearful reaction having 'not watching the farm'.

Hence, real-world absence from the all important EU small car watch, whilst over-focusing executive, management and staff resource upon the extension reach of: non-EU areas, new entry into CUV segment, introduction of high-line DS. In addition expended effort to proactively manage public and investor perceptions - via concept cars, halo cars, PR & marketing initiatives such as Mu & Peugeot City - rather than fundamental realities of the business.

Such observations cannot be simply brushed aside, especially so if indicative of an inherent inability to evenly spread attention as necessary and implement all important required product actions to retain a once highly competitive position.

Of course EM attention, NPD attention and Retail Channel attention are all critically necessary. Especially so when a company is trying to escape its near overt 2/3 sales dependence upon a singular regional market, within which it relies upon tight segment(s) concentration. In this mould it is similar to say FIAT but is under greater pressure to be seen to be doing something relatively radical as it does not enjoy the similar foreign footprint or market standing of FIAT or other peers.

Yet giving away the home advantage in such a core arena as small cars only ultimately precipitates a far harder fight both at home and abroad. After all it is the commercial reality of net income and working capital levels that underpins the transition of ' PSA Futurology' into successful commercial extension achievements.

At a time when the corporation offers “Jam Tomorrow” - and adding seeming sizable sums to its fixed cost-base to do so - it must be seen to be capable of baking its bread and spreading its butter as convincingly at home as in the almost self-perpetuating EM regions.

Far more exacting detailed transparency about the exact ingredients (costs), recipe (targets) and baking fortunes (results) would be welcomed by near-term large scale institutional shareholders, mid-term governmental debt-holders and longer-term (Mu linked) expectation from possible private equity.

For PSA the development of Mu was undoubtedly undertaken to formulate a powerful yeast in the ostensibly cloying dough of the western auto-sector. However, although brilliantly dreamt-up as a brand name given its overtones of electrically-charged particle mobility, it also more recognisably represents the value of a friction co-efficient between 2 forces.

Thus PSA's real task is to better secure near-term value-creation as solid stepping stones to its more esoteric long-term goals. Doing so will regenerate its own credibility and reduce any level of investor frustration and friction.

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.