Note: Fiat Chrysler has run up quite a bit since the new year (up 30%). I was buying over the course of Sept to Dec last year so my average cost is significantly below the current price. Anyway, I think there might still be a little bit of runway on this one but not as much as before.
“I’ve always had this incredible sense of urgency, I’ve always had this desire not to let things fester and to really seize the moment, because it’s serendipity.”
Sergio Marchionne
Preface: To get you excited for the drabness that might or might not follow, I’ll let Eminem maybe start things off in what I think is a contender for best ad of the past decade. I present to you “Imported from Detroit.” American Exceptionalism FTW!!
Thesis.
Simply put, Fiat Chrysler (FCA) is run by a potential outsider CEO in Sergio Marchionne whose 5 year business plan has the business potentially earning an adjusted net profit between €4.7-€5.5B in FY2018. A conservative 7x earnings and current market cap of €29.5B suggest a 12 month price increase of between 12% to 31%.
Business Overview
FCA designs, manufactures, and sells mass market vehicles in 4 regional segments (NAFTA, LATAM, APAC, EMEA) mainly under the brands Fiat, Alfa Romeo,, Dodge, Ram, Jeep, Chrysler. Its luxury segment includes Maserati and it also owns a components business, (Magneti Marelli, Comau, & Teksid). It previously owned Ferrari that was spun out January 2016.
Brief History
Fiat was founded in 1899 in Italy and Chrysler founded in 1925 in America. In 1998 Daimler Benz paid $36B for Chrysler only to offload an 80% stake for $7B in 2007 to Cerberus Capital. During this period Fiat was experiencing somewhat of a renaissance under Sergio Marchionne who had become CEO in 2004. The 2 companies fates become intertwined in the depths of the global financial crisis. In January 2009, a Chrysler on its last legs signed a strategic alliance with Fiat which might have essentially given Fiat 35% of Chrysler for nothing. In a fight with holdout creditors Chrysler was forced to apply for Chapter 11 bankruptcy and emerged in June 2009 from a 42 day bankruptcy process with the UAW pension fund (68%), Fiat (20%) , and the US & Canadian governments as principal owners (balance), in addition to loans from the US government. In 2011 Chrysler recorded a quarterly profit and paid off the government loan. The current Fiat Chrysler company was formed in 2014 when Fiat acquired the 41.5% it didn’t own to make Chrysler a wholly owned subsidiary. The deal cost Fiat approx. $5B and the assumption of $5.5B in pension liabilities.
Industry Overview
The automotive industry is cyclical with high capital expenditure requirements. About 90 million units are sold annually, about 17M of which are sold in the USA. The largest players are Toyota & Volkswagen who sell about 10M units worldwide, with Fiat Chrysler coming comes in at number 7 selling approximately 4.7M units. Dealers and retail customers usually finance purchases of vehicles from manufacturers. The industry has gone through cycles of restructuring and the US manufacturers of today are not the same as they were pre financial crisis, with lighter balance sheets. That being said, the cyclical/high capex dynamic still remains and they deserve the low multiples the market gives them now.
Fiat Chrysler’s 5 Year Plan.
In May 2014 FCA announced a 5 year to sell 7M cars in 2018, have €132B euros in revenue, €4.7-€5.5B in adjusted net profit and approximately €0.5-€1B in net industrial debt. The repositioning was to leave Jeep as the marquee brand, have Chrysler be more competitive in North America, focus on higher margin truck/suv lines like Ram and revamp Alfa Romeo in the premium segment and Maserati in the ultra luxury segment. The plan was updated in January 2016 to revise the FY2018 revenue target to €136B Euros, adjusted net profit of €4.7-5.5B, an even have a net cash position of €4-€5B euros. EBIT Margins from the original plan have been increased for North America (6-7 to 9%), and EMEA (2-3% to 4%). Admittedly though, the Brazilian market has continued to face weaknesses and EBIT margin estimates have dropped from 10 to 7% for that region. Since the plan was announced Ferrari has been IPO’d and spun off and the ring-fencing behind FCA’s US’ cash has been removed allowing for a unified global financing platform.
Jeep: The cornerstone of this plan has been the revamping of the Jeep Brand which has enormous brand equity all over the globe, especially in China. In 2009 only 338k Jeeps were sold worldwide, the 2015 number was 1.2M units and Jeep is now selling 1.5 units a year. The original plan of 1.9M units by 2018 was revised to 2M units. This is supposed to be led by mostly APAC performance, which Fiat expects to increase from 100k in 2015 to 500k in 2018.
Sergio Marchionne: Potential Outsider CEO chained to a terrible business?
Born in Italy, Marchionne’s family moved to Canada when he was 13. He subsequently finished a degree in philosophy from the University of Toronto and then one in commerce and an MBA from the University of Windsor. As if that was not enough he also obtained a law degree from Osgoode Hall Law School during this time. Sergio is also a CPA. So you have an individual with a background in law, accounting, business & philosophy. He then had solid careers at Deloitte, Lawson Mardon (packaging), Glenex Industries (biotech & plasma videos), Acklands (industrial supply), Alusuisse (aluminium & chemicals), & SGS (certification & inspection services) before landing the CEO role at Fiat CEO in 2004, their 5th CEO in 4 years. Sergio changed the leadership structure from the strong one man decision maker model, vestiges of the Agnelli dynasty to finding young, engaged leaders buried underneath heaps of bureaucracy throughout the organization. He followed this by setting BHAGs (Big Hairy Audacious Goals) then giving his team the autonomy to reach them. For instance, he set a €2B 2007 net profit target for 2007 for a barely profitable Fiat when he arrived. This is similar to the ambitious 5 year plan at FCA. When Sergio took over Fiat in 2004, it had a market value of about €5B. They have since spun off CNH Industrial and Ferrari, which both have market values of approx €17B and €18B respectively. Add that to FCA’s €29B market cap for a total of €64B. 13 years, 13 bagger, partnering with Marchionne, not bad. Marchionne plans to retire at FCA’s annual meeting in April 2019. He will be sorely missed but plans to stay on as Ferrari CEO until 2021. He has only been able to achieve this feat with the full support of the Agnelli family as the cornerstone shareholder. John Elkann, the chosen heir of Gianni Agnelli, handpicked Marchionne as CEO after being thrust into leadership of the Agnelli fortune in 2004 at the tender age of 28. Elkann, who was elected to the Fiat board at the age of 21, has an interesting story himself but a story for another day.
Valuation
The 5 year plan has FY2018 adjusted net profit for FCA at between €4.7 to €5.5B. Marchionne is on record reiterating these numbers as late as Q42017. With prior execution and visibility only 1 year away it is not as dangerous going with these number as say in 2014. They might not hit the 7M vehicle target but fleet mix is being focused even more on the higher margin Jeep & Ram businesses. GM trades at a P/E of 9.5 and Ford at a P/E of 12. Say you give FCAU a more modest P/E of 7 due to its smaller scale, it still implies a market value anywhere between €33B and €39B, 12% to 31% above current prices.
Another view: When rumors circulated last year that China’s Great Wall was interested in Fiat Chrysler, specifically Jeep, the rumored price for Jeep alone was €23B euros. The components business does about €10B of revenues and €500M of EBIT, most of which is Magneti Marelli. Marelli is rumored to be spun off for €5B in 2018. According to the 5 year plan FCA will end 2018 with €5B Net Cash position and has a pension liability of €10B. Maserati does €400M in EBIT and could command as much as €8B as a standalone luxury business but let’s just use €5B to be conservative. Doing the math (23+5+5+5-10) leaves us roughly in line with current market cap of €28B. In other words you can own the Dodge, Ram, Fiat, Alfa Romeo, and all the other minor brands for free. The RAM brand alone is expected to sell around 600k units in 2018. Trucks, especially those produced in North America, are generally high margin, and average pre tax income is rumored to be €4000 per truck. At 600k trucks that’s €2.4B in pre tax income. At a conservative 5x EBIT, the North American RAM unit, which we are buying for free, is worth at least €12B and would imply prices 40% higher than current. The Alpha Romeo Giulia was named Motor Trend’s 2018 Car of the Year. From a standing start of practically no units sold in North America, it sold 12k units in 2017. The Fiat brand is expected the sell 1.5M units WW in 2018 and Dodge 600k units. All of that for free!!!
What could go wrong?
Cyclicality: The business is cyclical and North America SAAR anywhere near the results we saw in the global financial crisis (10M) makes most car company business models unsustainable. With average car fleet age close to 12 years and replacement rates from the natural disasters of 2017 it is improbable but not impossible that car sales drop dramatically in 2018. In addition, the car companies are going into 2018 in much better condition than they entered 2008, as can be seen by Fiat Chrysler possibly entering next year in a net cash position as opposed to being saddled with debt.
Self Driving Cars: There is this view that self driving cars are imminent. I do not believe anything substantial can happen on this front in the next 5 bto 10 years. We may be 95% to 99% of the way there as far as technology goes but the nature of driving is that only 100% is acceptable, or at least 99.999999%. Another short of this leaves room for serious road accidents. The potential for serious liability cases will also be a deterrent for full blown automation. It is one thing to have product recalls and the isolated client lawsuit but a whole different ball game when blame is put on the automation and hence the manufacturer.
2018 target not met: This would not be the end of the world as FCA is on track to earn €3B in for FY2017. If they can at least repeat this figure in 2018, it implies a forward P/E of 9.8.
Conclusion
Although I’m not buying in at these prices, I’m holding at them (which is slightly illogical when you think about it, and I call myself an intelligent investor!). I’m leaning towards FCA hitting the higher end of their targets, with plans just announced to invest an additional $1B in US operations. I’ll become uncomfortable around €40B-€45B of market of market value.
Links
Sergio Marchionne on 60 minutes , Bloomberg Q&A , NY Times profile , HBR Fiat Case Study , Jeep sale speculation , 5 Year Business Plan Update , FCA Investor Relations , A couple links from 2009 restructuring process , Thesis’ by Mohnish Pabrai, Scott Miller , Adam Wyden , & the Oracle from Omaha blog , Marchionne/Chrysler HBR Case , Reiteration of 2018 Targets & Magnetti Marelli Spinoff , Bill Vlasic’s Once Upon A Car , 2018 $1B Investment Plans
Security (in) Securities 