Fiat Chrysler Automobiles research update titled, “Fasten Your Seat-Belts.” Greenwood Investors
Fiat Chrysler Automobiles – In A Nutshell:
The gift that keeps on giving. When you take a company hated by investors, add the best CEO in the industry, a group of under-invested brands, a focus on ROIC and margin expansion, all at a cyclical trough in Europe, you get a powerful brew of value-creating potions. While the company committed to significant margin expansion in 2017 and 2018, we believe the company will be able to make substantial progress over the next six quarters as it reduces North American incentives, starts up new factories in Brazil and China, and most importantly, fires up its Italian factories to support the European recovery along with the new Alfa Romeo Giulia and Maserati Levante. With the IPO of Ferrari coming up in October, and subsequent spin-out of its shares to Fiat Chrysler Automobiles holders in the summer of 2016, we make the case that Fiat Chrysler Automobiles shares could nearly triple by the end of next year. The two most-cited concerns we hear about the company are its low North American operating margins and its indebtedness. Both concerns will be alleviated in the near term. Fiat Chrysler Automobiles remains our most attractive and largest position.
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Recent Bear’s Arguments & Our Responses
- Fiat Chrysler Automobiles is desperate to merge with another company because it’s at risk of missing its key industrial plan. Media rumors are completely false, and the company just committed to accelerating the plan.
- The U.S. automotive industry is peaking. While growth will be low to nonexistent in the next year or two, consumers are still catching up from years of pent-up demand and the fleet age remains at its all-time oldest levels.
- Chinese automotive demand is slowing in the middle of a robust capacity expansion in the country. Correct, it is slowing and capacity is still being added – including new Jeep capacity. Jeep localization will result in a 6-7x increase in its addressable market, offsetting weakness.
Full Research Update
It seems that we have a recurring pattern. Every time we update our analysis on Fiat-Chrysler Automobiles (FCA IM or FCAU), the stock is wrapped up in volatile trading reactions to headlines about mergers and acquisitions (M&A). When we last updated our research in August of 20141, traders had dramatically negative responses to false stories that the merger with Chrysler was called into question. Obviously, the merger was agreed to on January 1 that same year, and the only doubt was whether or not the company would complete an up-listing on the NYSE and change its tax domicile. The merger ended up going through, the stock traded higher, and nothing fundamentally changed at the company.
Fast forward to the summer of 2015, and there are false merger stories circulating again on Fiat Chrysler Automobiles. This series of mistruths began with Sergio Marchionne’s excellent presentation Confessions of a Capital Junkie, in which he argued the entire auto industry was unable to earn its cost of capital, and the long-term viability of the industry depends on finding cheaper ways to innovate, which in turn translates into a need to eliminate wasteful and duplicative spending on next-generation engine and autonomous driving technology. We would encourage any readers that haven’t seen the presentation to stop right now, click the link and read one of the most honest and interesting management presentations we’ve ever seen.
In the ensuing weeks of Sergio’s presentation, M&A machinations of the media began circulating, which in turn led others to recirculate the same stories. News of one email that Sergio sent to the CEO of GM has turned into false allegations that Fiat Chrysler Automobiles was actively recruiting activist investors and other constituents to encourage GM to entertain a merger with Fiat Chrysler Automobiles. Sergio has directly refuted these reports,2 yet the M&A stories continue. It seems stories about potential mergers sell so much better than the actual truth.
GM’s CEO has foolishly dismissed even the possibility, and although GM has a lot of wood to chop in bringing its own divisions up to competitive benchmarks, stubbornly rejecting a discussion without considering the argument or potential for significant industrial disruption is the correct way to obsolete a business over time. We thought it was interesting that Marchionne has met with Apple’s CEO Tim Cook as well as executives at Tesla.3 Sergio is leading the discussion with these aspirational car-markers so as to position Fiat Chrysler Automobiles front and center if and when Apple decides it wants to enter the automotive manufacturing business. We’ve always been intrigued by shares of GM given the valuation, but there’s no one we’d rather in the driver’s seat than Marchionne. There has to be some element of envy amongst the shareholder base of GM with regard to Fiat Chrysler Automobiles – since the last time Chairman John Elkann approached GM about a potential merger in 2012,4 GM’s shares are up 30% and Fiat’s have tripled. And we think they’re about to triple again – which is what brings us to the reason we’re writing today after all.
Triple. That’s right, shares have nearly quadrupled since we acquired shares of then Fiat S.p.A., and we think even without a recovery in China or Brazil, the company’s operating income expansion in the next two years, coupled with the spin-off of Ferrari and the likely sale of Fiat Chrysler Automobiles’s components divisions, shares are worth over €40 per share.
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