Fiat Chrysler’s Europe Progress Impresses, But Doubts Remain

Fiat Chrysler’s Europe Progress Impresses, But Doubts Remain.
U.S. Profitability, Maserati Margins Worry Some.

“FCA is a risky investment, but we believe it is the most under-rated (U.S.) auto manufacturer”

Fiat Chrysler Automobiles (FCA) moved into the black in Europe last year and hopes to repeat that for all of 2015, but its latest financial results include disappointing profits from North America and its overall prospects worried some investors.

FCA, which has moved its stock market listing to New York and plans to spin-off its luxury sports subsidiary Ferrari later this year, reported its operating profit for 2014 rose seven per cent to €3.65 billion. Revenues rose 11 per cent to €96.1 billion last year. The latest profit numbers were at the bottom end of analysts’ expectations.

CEO Sergio Marchionne said FCA recorded an EBIT (earnings before interest and tax) profit in Europe in the fourth quarter of €32 million before interest and tax, its first quarterly profit since the second quarter of 2007. Marchionne, in a statement after the results, said he hoped black numbers would remain in 2015, a year earlier than scheduled. Operating losses in Europe last year were cut to €109 million from €505 million in 2013.

Morgan Stanley liked what it saw from the overall results. Others weren’t so sure.

“Fiat is making margins of only 3.4 per cent, with an R&D accounting uplift. It is barely breakeven in two of its three main regions, even if lifting Europe out of losses in Q4 is a triumph. Chrysler’s results continue to disappoint, showing zero operating leverage in Q4 (€2 billion of additional revenue in Q4 resulted in zero additional EBIT). Fiat burnt cash in 2014 – something that won’t change anytime soon, given the need for catch up spending,” said Bernstein Research analyst Max Warburton.

Warburton pointed out that FCA has annual interest costs of €2 billion.

But Morgan Stanley said FCA, which uses the euro currency, was its top pick among North American auto manufacturers because it stood to be a major beneficiary of dollar strength. It also had heavily euro-currency contented brands like Ferrari and Maserati.

Not everything in the garden was rosy though.

Dive
Morgan Stanley analyst Adam Jonas wondered why FCA’s NAFTA (North American Free Trade Association) margins were so weak – at 4.0 per cent compared with his expectation of 7.4 per cent. But Jonas said his forecast of FCA’s 2015 operating profit of €4.74 billion was 10 per cent above the midpoint of the company’s forecast range.

After the financial news, the stock price took a dive of more than two per cent, but this could have been because the price had run up significantly, as investors increasingly liked what they saw with FCA, and were simply taking profits.

Jonas was happy to stay with FCA.

“We would use this opportunity (stock price falling) to establish a position in FCA shares which are our top pick in U.S. autos. Despite the many cyclical and fundamental challenges facing the global auto industry, we see upside to a variety of company-specific items for FCA including extracting value from Ferrari, Maserati and Jeep, improved financing and a benefit from a stronger dollar,” Jonas said.

Citi Research said FCA’s latest numbers were neutral to marginally disappointing and suggested that gains expected from the euro weakening against the dollar might be less than some investors imagined.

In a report, Citi Research said FCA was its least favoured mass market auto manufacturer and it didn’t expect the Ferrari spinoff would reflect the kind of market valuation a luxury goods company would command.

“Among the mass market players it (FCA) is least exposed to Europe though does benefit in terms of a weaker Euro on translation of global-operations. Our main disagreement with bulls has been the valuation of Ferrari, broadly it seems the consensual view in the market is to accept FCA’s assertions that Ferrari merits full luxury goods multiples. We however think there are reasons around regulation and technology to see a discount to traditional luxury goods as merited,” Citi Research analyst Philip Watkins said.

Weak
Evercore ISI, also among the doubters, pounced on the weak profit margin performance in North America.

“Despite the fact that the U.S. market is in an extremely healthy position and FCA reported NAFTA shipment growth of 11.4 per cent, the company managed to make €68 million less in 2014 than in 2013 in the region, excluding unusual items,” said Evercore ISI analyst George Galliers.

“Further cause for disappointment at Q4 was Maserati where the margin came in at 8.9 per cent, a step down from the 13.8 per cent margin seen at Q3 and in line with the sub nine per cent margin which we saw in the first half. We have given FCA the benefit of the doubt, that Maserati can be a double digit margin going forward. This could now prove optimistic,” Galliers said.

Galliers said FCA’s stock price was too expensive compared with its rivals.

“We continue to question why investors should pay more for FCA than for other names in the sector which are generating positive free cash flow and sitting on positive net cash positions,” he said.

For Morgan Stanley though, the sky is the limit.

Under-rated
“FCA is a risky investment, but we believe it is the most under-rated auto manufacturer (imported) from Detroit and the best risk-adjusted vis-a-vis GM and Ford. An ultra-high-performing culture built around Sergio Marchionne’s infectious enthusiasm and legendary work ethic has transformed Fiat and Chrysler from disjointed regional players to a global powerhouse with some of the strongest brands and one of the most formidable vehicle platform strategies in the industry. The team is making many of the tough moves necessary to keep its place in a rapidly changing industry,” Jonas said.

Bernstein’s Warburton agrees about the Marchionne factor, but worries this won’t be enough.

“Yes, Fiat is run by a genius with a unique focus on shareholder value. Yes, Fiat contains a number of attractive businesses. Yes, some of the growth plan may work – Jeep, China, Maserati etc. But haven’t expectations got far too high for a company that remains so fragile?,” Warburton said.