Investment Thesis
Fiat
Chrysler Automobiles (F IM) is an Italian automobile company that has full
ownership of luxury nameplates including Ferrari, Maserati, and recently
acquired 100% control of Chrysler. While the profile is now largely (est. 50%+
sales and 70%+ EBIT) North America-based with a big Luxury component, FCA still
trades at a discount to its closest peers in the US and has a European analyst
base that is focused on the smaller European and Latin American parts of its
business. We believe Chrysler’s value and the potential synergy is still being
glossed over, and see 50%+ upside given its levered capital structure with
multiple event path to capture overlooked optionality. Blue-sky case is 100%+
upside, bear case is -20% downside, and nightmare case is 50% downside. We see
(1) the pending NYSE relisting between Oct 2014 and 1H14 and (2) analyst day on
its next 5-year plan and luxury game-plan on May 2014 key transformational
catalysts to prompt the rerating.
Why does this opportunity exist?
·
Despite that
Chrysler carries the firm, only 2 out of the 32 analysts that cover
Fiat-Chrysler are actually in the US, making them vulnerable to confirmation
bias – overemphasis on Fiat’s European Division.
·
Fiat’s European
listing, coupled with negative sell-side consensus, could indicate that it is
largely off the sight for most US institutional investors as a long candidate.
·
Fiat had
historically been associated with heavy European exposure, low-cost & low-quality
vehicles, and weak FCF, earnings, & margins due to mismanagement and recent
investments to catch-up, making it unlikely to be picked up by traditional
value screens.
·
The complexity
behind Fiat’s Chrysler acquisition and Chrysler’s tinted post-bankruptcy
profile could both be deterrents for further investigations.
Background
For
those unfamiliar, Fiat has a storied history: Founded 115 years ago, it had
been under the tight empire-building grip of the Italian Agnelli family to
“power anything that sails, drives, and flies”. As the industrial conglomerate
is passed down to John Elkann, the chosen heir of Gianni Agnelli, at the young
age of 27 in 2003, it was burning through 2 Bn Euro of OCF / year, runs a net
debt of 5.2 Bn Euro, and barely had 6 Bn Euro in market cap. Fortunately for
this family and the shareholders, a new leader, Sergio Marchionne, was brought on-board in late 2004 and staged an
exceptionally shrewd turnaround for Fiat by shedding noncore assets, whipping
the cost structure in-place, and milking $2 Bn of much-needed cash from the
failed JV with GM in 2005. Fiat turned profitable 1 year after Sergio’s reign
and, by 2007, showed 2 Bn Euros in FCF and turn into a net industrial cash
position.
Sergio,
however, was not resting on his laurels: being the market share gainer in the
A&B small car segment in Europe, Fiat automobiles was heavily exposed to a
margin-light segment where over-capacity was perking its ugly head as the cloud
of financial crisis gathers. To survive in a faster world filled with giants
such as Volkswagen and Toyota, Fiat needed (1) bigger cars above the D segment
and full-fledge luxury brands for thicker margins (8%+) and (2) a global
footprint to achieve economies of scale in manufacturing, R&D, procurement,
and dealership relationship.
And
the opportunity came knocking when Chrysler spiraled downward and US government
was desperate for an operator to help keep Detroit’s jobs. Through a series of
transactions between 2009 and Jan 1st, 2014, Fiat executed a series
of transactions whereby it (1) spun off its industrial asset CNH Global in
2010, (2) paid a total $3.718 Bn
of its own cash to acquire 100% of Chrysler from various entities. Sergio did
it again with Chrysler – and turned it from a bankrupt entity with $4 Bn net
debt to now a healthy entity that generates ~$2 Bn in FCF with a small net debt post-deal.
As
the final transaction closed with VEBA’s 41.5% stake (plenty of coverage on
this topic), The Fiat Group is restructured into a new entity called “Fiat Chrysler
Automobiles” (Or “FCA” hereon) engaged in manufacturing of automobiles and some
auto-parts. Its model line-up currently spans Chrysler, Dodge, RAM, Jeep, Fiat,
and Lancia, as well as the renowned Ferrari, Maserati, and Alfa Romeo.
The 1st point I will make: FCA
IS a US company similar to a mix of GM and baby Porsche.
The
full Fiat-Chrysler integration is transformational on many levels. The obvious
of which is that, as indicated by the sales and EBIT break-down by geographic
segments, FCA’s Revenue and EBIT profiles, thanks to Chrysler, is very similar
to that of GM and F. What is more remarkable is that FCA actually has less European exposure than Ford
in terms of sales. Historically FCA has also bested GM and Ford in its European
margins at the -3 to -4% range. Additionally, FCA breaks out its Ferrari and
Maserati segments under the “luxury” line, combined of which generates 6% of
FCA’s top-line but ~21% of
FCA’s bottom-line. Assuming worsening Europe, break-even LatAm, and small APAC,
we project that FCA’s North American and Luxury line together generates >100% of the firm’s EBIT. Given
the similarity in profile, it would be fairer to value FCA as a North American
company with a luxury renaissance and depressed overseas exposure, rather than
giving the focus on Europe and Latin America as most currently does.
And
FCA is trading at a discount to
GM and F if we entertain such a comparison – after adjusting for capitalized
R&D and estimated pension accounting. Please note again that our 2015 base
case is baking in:
(1) Continuous
share loss in Europe with negative 2-3% margin.
(2)
Massive share loss in Latin America to ~10% by 2015YE (vs. 14% current) with 0.5%
margin (vs. 5% in 2013)
(3)
Slowing APAC growth with depressed 5.5% margin (vs. 7% in 2013)
(4)
Market share remains at 11.5% in North America with NO EBIT margin improvement
despite synergies @ 6% (300 bp below GM and Ford).
Even in such a case more
bearish than what most analysts anticipate, FCA still screens 15%+ cheaper
compared to GM and Ford in multiple terms and trades at a 1-turn discount to
the historical 4x EV/EBITDAP rule-of-thumb – almost all of which are
attributable to Chrysler’s robust NA operation and Ferrari + Maserati’s strong
profile.
So
now that we know FCA is inexpensive in a conservative scenario, let’s see what
can go right. Before delving in to the details, the points are that (1) NA will continue to hum potentially
higher market share and margins, (2)
Brazil can surprise with its mid-size offerings, and (3) CapEx in Europe had not gone to waste and higher utilization
will follow the Maserati & Jeep ramp.
Take North America for an example. For the past 40 years
and counting, 1 in every 18 Americans purchases a car per year. For 2013, the
number is 1 in 20, which translates to roughly 15.9 mm cars. One can
hypothesize about a new paradigm of internet age teenagers less inclined to
drive, but I think it is more rational to bet on normalization towards the 1 in
20 number given that these teenagers are not the main buyers of new
automobiles. Should normalization occur, US annual auto sales can increase
another 10.5%, or ~1.7 mm cars to 17.5 mm cars per year. Thus, assuming a total of 6% SAAR growth
for 2014 and 2015 combined is likely a high probability event. So the
underlying driver for 50%+ of FCA’s sales should be robust if they can capture
it.
And capture it they can. After 6 years of slumber circa
2008 – 2012, FCA’s product cadence is kicking in full-gear into 2014/15 with
> 20 product refreshes and introductions per year, with its RAM light-duty,
Dodge Dart, Jeep Cherokee, and Chrysler 200 & 300 series just recently
being introduced and enter the growth phase of the product cycle. The other 2
important points to note are that (1) Chrysler managed to advance its market
share from the trough of 8.8% in 2009 to its 11.3% market share in 2013 largely
running on its legacy pipeline without utilizing Fiat’s R&D, design,
and manufacturing assistance fully, and
(2) Chrysler’s brands have logged 5 quarters of consecutive improvement in JD
Power’s IQS rankings vs. the industry average, with the total problems / 100
vehicles decreasing from the high of 156 in 2007 to 119 in 2013; while quality
is largely subjective and Chrysler brand ranking is still below peers, the
overall industry dependability (including Chrysler’s) has improved steadily
over the past 10 years and, anecdotally, Chrysler models after 2011 have vastly
improved the interior design and reliability and, according to Sergio
Marchionne, these cars “have nothing to apologize for”. Bottom-line is, while
the brands may ebb and flow, we are
confident that FCA can retain its 11.2% market share for next 2-3
years, if not expand it now that Fiat and Chrysler are fully collaborating.
Importantly,
FCA’s North America trading margin is
~5 %, still below the 8-9% GM and Ford currently are and their 10%+ target.
The sole reasons behind the 400 bp gap in 2009-2013 are (a) lack of economies
of scale, (b) integration efforts, (3) increased R&D spend after years of
deprivation and (4) revamped marketing effort post product refresh and new
launches. As FCA gets over such 1-time humps, shares purchasing, R&D, and
marketing resource with Fiat, and D&A eventually normalizes, the firm’s NA EBIT
margin has years of expansion to come, potentially adding an additional 1 Bn
Euro of EBIT with a 200 bp margin expansion (or 5 Euro / share of value using
6x EV/EBIT).
Plenty
of attention had been focused on Europe and Latin America, citing over-capacity,
share loss, and negative EBIT margins. The concerns are true, yet (1) little
optionality is given to Fiat’s Pernambuco plant expected in 1H15, producing
mid-size cars to target the burgeoning middle-class, (2) Fiat’s Italian plants,
running at 41% of capacity, is being retooled to fulfill production needs in
other geographic regions (Instead of shutting the plant down to incur
redundant, 600 mm + Euro cost and incur massive fixed CapEx in the US). This
retooled asset was widely criticized since it generates (if not burns) little
EBITDA and cash-flow, but doing so is not only the lesser of 2 evil (vs.
engaging in negative ROIC project for mass products in a European market with
sizable overcapacity), the plant is finally set to produce into 2014 / 2015 as
the Maserati line-up materializes and can do much more for Alfa Romeo for years
to come.
In
particular, Maserati’s trajectory reminds us that of Audi and Porsche’s: Before
Volkswagen built Audi into a behemoth global luxury brand, it was a small niche
luxury automaker. Similar to Fiat, Volkswagen also long had under-utilized
capacity in Germany, and post Audi’s integration and sharing w/ Volkswagen cars
of similar size, filling the under-utilized capacity with Audi production
easily spread operating costs of factories to a larger set of vehicles. Audi and Porsche both branched out from
sports cars into luxury sedans and SUVs (Audi A4-A6 before 2000, Audi Q-series
in 2007, Porsche Cayenne in 2003, Porsche Panamera in 2008, and Porsche Macan
debuts in 2014) and enjoyed runaway success. The large car product lines now
carry both firms in terms of profit margin and absolute EBIT numbers. While
Maserati’s 50k unit target is cited by some as aggressive (from the current 15k
base in 2013), we see it as achievable with the Luxury sedan Ghibli and SUV
Levante (peers easily crack 20-30k units per annum in the US alone and >100k
worldwide). By 2015, if the goal is achieved, we see Maserati as a 4.4 Bn Euro
business that can generate 350 mm+ EBIT per annum, valued at > 2Bn Euro. The success can add another 0.80+ Euro /
share to FCA’s valuation (add’l 180 mm EBIT at 6x multiple).
All
these undertakings would not be possible without the heavy capital expenditure
FCA committed to. While there is little question that FCA will generate little
free cash flow, note that the firm
has outspent most if not all of its competitors in R&D + CapEx as % of
sales to catch up over the past 5 years. We believe the money is
well-spent to execute a long-due catch-up, a very busy product launch/refresh
business plan, and sizable retooling / upgrade on its European capacities to
produce luxury + SUV line-up.
The
current elevated CapEx spending at ~$ 2,000 / unit and >6% of annual sales
will not continue indefinitely. Should the CapEx level normalize, FCA is set to reap 2 – 3 Bn Euro of
additional cash-flow, which is ~20-30% of its current market cap and can retire
all its industrial debt in 4 years.
The
Buy-in to this Fiat-Chrysler joint-venture, we believe, ultimately resides in
US institutional investors’ hands. Now a UK-domiciled company to maximize
tax-savings, FCA will be listed on
NYSE – we believe this is a remarkable catalyst that will prompt the rerating
as it will easily become a levered, US recovery story and attract heavy analyst
coverage from all NA investment banks. In Sergio Marchionne’s own words
during the 4Q13 conference call:
“In
typical style of his house, we will try and get this done as quickly as we can.
We have the end of 2014 here. I think it will be great when I make this
comment, Palmer who is sitting next to me, hopefully I’d like to replicate the listing in New York as of October the 1st
of this year. We’ll see that we get it done. It’s a relatively large
undertaking….But I think we are -- we
have done a lot of work…the IPO of Chrysler which was Thank God it will
start early enough and so that should
come in hand and preparation of the SEC filing documents that documents
are required to be filed with the SEC in 2014.”
Event-path
My event-path scenarios hinge upon 5 key
drivers:
- Whether
the market volume will out-perform (10% US growth in 2 years) or underperform
(broad-base decline in market volume)
- Whether
FCA can out-perform in the US and deliver 11.3% market share @ 5%+ margin or
under-deliver at 10.5% market share @ 4.5% margin
- Whether
Europe, LatAm, and APAC will collectively get better or not
- Whether
Maserati will hit 50k target at 7-8% margin or under-deliver @20k w/ 4% margin.
- Whether
the stock rerates to 3.0x, 3.5x, or 4x EV/EBITDAP.
In
my base case (scenario 11), I assume
everything works out except for Europe, LatAm, and APAC and the stock rerates
to at least 3.5x EV/EBITDAP. In this case (see below), FCA is on its way to
deliver ~8.2 Bn Euro of EBITDAP in 2015, and will deliver ~30% upside with an E 10 stock.
My bull-case (scenario 9) occurs if (1)
market actually rerates it to 4.0x, or (2) Europe, LatAm, and APAC manage to
get better, in which case there is ~50-75%
upside to be had with a E 11.5-13.5 stock.
My bear-case (scenario 15 and/or 19) is 25-30% downside if (1) rerating does not happen and the
stock remains at 3.0x, and (2) either FCA botches North America growth, or the
world market falters and falls into flat / negative growth.
In
my blue-sky case, Markets across the
world deliver better-than-expected growth, and FCA manages to generate 9 Bn
Euro of GAAP EBITDAP in 2015. At a 4x multiple, the stock is set to double with
110% upside.
In my night-mare
case, should the world market cracks for 2 years, FCA loses market share in
all of its markets and swings to losses in LatAm, and Maserati turns out to be
a dud with 20k units per annum at 5% margin, and the stock remains at 3.0x, FCA
has 50% downside.
Risk factors
- If
North America breaks (i.e. US economy falters and US SAAR begins its decline),
then all bets are off, it is still a bet on US recovery with the tailwind
multiplier of rerating. But if the base is not there, there is nothing to
multiply. This must be a bet that one is willing to take.
-
FCA remains highly levered vs. GM and F at ~3.2x gross debt / EBITDA and ~1.3x
net debt / EBITDA. While Marchionne remains confident on its ability to
refinance on the Fiat side and Chrysler can funnel over ~1 Bn Euro per annum,
FCA will remain volatile and may gyrate violently based on perceived and/or
actual execution.
-
Latin America downside may go beyond the break-even we currently assume for the
bear-case. Although the negative impact should be largely masked should the
rerating occur alongside North America’s performance.
-
Marchionne continues his effort to revive Alfa Romeo into a low-end luxury
brand to compete against the big 3 German brands. I hypothesize that the
build-out will be in Europe and shares the same architecture with Chrysler and
Dodge. Make no mistake – the game-plan makes sense, and the 5k-50k-500k unit
roadmap for Ferrari-Maserati-Alfa Romeo is exciting, yet building such a brand
requires massive capital expenditure and working capital requirements perhaps
too big for Fiat to undertake and will likely bankrupt the firm if they
misstep. That will be quite unfortunate.
Catalysts
May 2014 –
Fiat 1Q Conference Call, also analyst day when Marchionne lays out its Luxury
roadmap and the next 5-year plan. Should be a positive catalyst if they point
to robust product refresh / launches and potential FCF positive in 2016.
Bond refinancing –
which should lower Chrysler’s interest burden.
Potential carve-out / sale of Ferrati,
Maserati, and Alfa Romeo – A partial sale could bring FCA the
cash they need just in case, although Marchionne noted that these are the last
resorts.
4Q14-1Q15 Relisting –
The catalyst every participant is waiting for.
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