Description

A material turnaround is underway and the market value has yet to catch up with the improvements.  Fiat Chrysler has returned from death’s door to the land of the living, and is now thriving.  The dramatic changes go beyond improvements in margins, cash flow, and the balance sheet to include updated exposures to regional trends in growth markets, a better product mix leaning toward utility vehicles, no further dependence on capital markets, lots of functional enhancements, and positive changes in culture. 

The tripling of the stock price off the very distressed bottom from ~€5 to mid teens, combined with investor perceptions of macro factors in their home market of Italy, masks what is only the beginning of their return to health.   With trailing revenues of €110B doing €13.5B of EBITDA with Capex of ~€8.5B, and a market cap of €25.8B with ~€6B of net debt, it’s a large global company selling beloved brands of automobiles far beyond its Italian roots.  In addition to Fiat, where 70% is sold outside Italy, Chrysler is a core earnings driver with brands that include Jeep, Dodge, & Ram, plus there are profitable halo brands Alfa Romeo and Maserati.  Overall, the NAFTA region supplied 54% of vehicles sold and 83% of Operating Income in 2017, on par with other major OEMs on whom they appear to be gaining incremental market share.

Adding to their storied automotive design history is Ferrari (RACE), which has put more than a few racing trophies on their walls over the years, and has done beautifully since it was divested in 2015.  RACE success implies a similar premium multiple could be obtained for the remaining halo brands.  If so, we are creating Jeep/Ram, an $85B company within that generates premium margins, at an extremely low valuation.

Multiples at FCA are not at all high at a trailing EV/EBITDA of 2.2x, EV/EBIT of 4x, and fwd P/E of 5.3.  Pension liabilities are manageable and don’t materially change these levels.  Guidance in EUR (€) is for €120B Revenues, €8.2B of EBIT and €4.7B of Net Profit.  Free cash flow should be at least €3.5B operationally for each of the next few years with an extra €1-2B of one time working capital squeeze-outs.  This excludes the upcoming spinoff of Magneti Marelli, a company with €5B of Revenues and €0.5B of EBIT, which is entirely gravy.  The spin and ongoing cash flow will bring their already comfortable debt level down to a net cash amount in the near term, and all debt currently trades above par with credit ratings climbing into investment grade zones, now at BB+/positive.

The turnaround includes a bit of cult of personality around the CEO, Sergio Marchionne, who will be leaving in 2019, after being with the company since 2004. Some investors worry about his departure as if it’s an instant setback, but he’s positioned the firm on solidly profitable footing with trends of improving margins already in place for the following forward outlook:

Continuing organizational fixes leading to better margins include a de-emphasis of fleet sales, which unfortunately carried low margin, substituted with an improved vehicle mix that includes greater SUV & light truck sales which carry substantial margins. Interest expense is way down to €1.2B this year and will stay below €1B going forward, plus they benefit from lower tax rates.  Other levers to pull include exiting their parts business, and establishing a US captive finance subsidiary. 

The Finco opportunity could be substantial given they are the only major OEM without one, and such financing provides competitors with 10% to 25% of earnings across the auto landscape.  They are currently deciding whether to buy an existing outfit or build a greenfield start-up, but they expect to fund up to €5B of initial Finco equity from available cash on hand on which they expect a 10%+ pretax yield.  The ample funding will allow an adequate credit rating for the Finco funding to be competitive.  Beyond financial benefits, there are strategic reasons to establish a Finco, not only to incent additional sales, but also to enable participation in emerging TaaS (Transportation as a Service) business lines.

FCA plans ~€10B of cost savings through 2022 via manufacturing efficiencies and purchasing higher volumes across a reduced number of architectures, leading to a combo of cash build, customer pass through, and reinvestment.  The fleet of available autos has been largely refurbished, and they will be expanding with introductions of 19 new models and 10 battery electric vehicles.

Morgan Stanley recently explored levers FCA can pull with a note on “7 steps” to a doubling of the stock, with assignments for incremental value per share:

Investor worries tend to harp on FX headwinds, Pension Liabilities, the CEO departure, and survival scenarios if SAAR of car sales drops to recession levels.  While there is little one can do about FX, the cash flows well underpin their liabilities which are soon to be net cash, and the next CEO may well be chosen from several strong internal candidates running business units.  Tim Kuniskis who ran Dodge/Chrysler and transitioned to Alfa Romeo and Maserati has footprints around the business. Mike Manley has made Jeep a best selling brand, and Reid Bigland increased unit sales 50% as head of US Sales.  Despite Marchionne’s shadow, this is a tight management team and any of the above would be fine leadership choices.

For downside scenarios, the company stress tests to a down 30% SAAR scenario where it expects to be able to remain operationally free cash positive.  Savings would come from variable labor costs, advertising cost cuts inline with volume declines, and other fixes.  In such a downbeat scenario, EBIT would be down ~€4B, and the €11.5B and growing cash cushion would be helpful if such a situation persisted.  The risk of such a stressed environ becoming real is currently perceived as remote, and I think the valuation and likely growth trajectory provide an interesting risk/reward.

In a rosier case where EBITDA grows from €13.5B to €15B over the next two years while the company becomes a net cash holder, the implied stock prices are significant increases on the market cap which is currently €25.8B:

EBITDA Multiple       Implied Stock Price

            2.21x                           €16.90  today’s stock price

3x                                €29 up 71%

4x                                €38 up 128%

5x                                €48 up 185%... each turn adds ~€10 to the stock when no debt…

…one can dream.

Catalyst

• Continued sales & margin improvements
• Investor comfort with upcomming CEO transition
• View to preimum value for components within:  Jeep/Ram  &  Alfa Romeo/Maserati
• Finco opportunity