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FCA Research Update: Fasten Your Seat-Belts

We are pleased to update our original research on Fiat-Chrysler Automobiles (FCA IM).

Click here to access the PDF version of our note. Summarizing our thesis briefly:

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 FCA holders in the summer of 2016, we make the case that FCA 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. FCA remains our most attractive and largest position.

Valuation Considerations

FCA EV

Two-Year EBIT Walk

FCA Ebit Walk

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Disclaimer:

This article has been distributed for informational purposes only. Neither the information nor any opinions expressed constitute a recommendation to buy or sell the securities or assets mentioned, or to invest in any investment product or strategy related to such securities or assets. It is not intended to provide personal investment advice, and it does not take into account the specific investment objectives, financial situation or particular needs of any person or entity that may receive this article. Persons reading this article should seek professional financial advice regarding the appropriateness of investing in any securities or assets discussed in this article. The author’s opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based upon proprietary research, and the information used in such process was obtained from publicly available sources. Information contained herein has been obtained from sources believed to be reliable, but such reliability is not guaranteed. Investment accounts managed by GreenWood Investors LLC and its affiliates may have a position in the securities or assets discussed in this article. GreenWood Investors LLC may re-evaluate its holdings in such positions and sell or cover certain positions without notice. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of GreenWood Investors LLC.

Past performance is no guarantee of future results.

This Post Has 13 Comments

  1. Excellent research. A lot of very good insights, and it looks like Q2 performance further demonstrates the company’s direction in your thesis.

    I’m curious to hear your thoughts on the recalls the company will be forced to do, and all the potential lawsuits surrounding that. Any change to your thesis?

    Again, great work!

    -Todd

    1. Hey Todd, thanks. The recall campaigns started in 2013 and have been fully accrued for (€650 million in charges last year). They took a charge on the fine in the most recent quarter, which as they detailed today is the results of missing the notification deadline by a few days on 2% of the recalls. This is a totally different situation than fire-related recalls, which were also a last-year event. FCA was held to a higher standard than F & GM on the crash-test fire issues, as the Jeeps called into question were designed to standards at the time, which everyone else was using for the design of SUVs. The incremental risk is not on FCA’s side, but F’s and GM’s as they haven’t had any recalls related to the same issue, but from what we understand had similar design (which again, were according to US regulation at the time). FCA has never complained about being held to a different standard, thanks for the opportunity to clear that up!

      1. Thanks so much for the response! I saw the accrual, and figured that was the case. Going back to your excellent car-by-car model from Aug 2014, did you arrive at your MSRP for each car model by using an average of all the car editions they have available, and then something similar for incentives as well? I was just curious to see where you were pulling incentive values from, since they can tend to vary depending on what region of the country you are in.

        Thanks again for this, and your recent valuation update today!

        -Tod

        1. We pulled incentives consistently from NYC region, with checks up in other areas. But wanted to keep it apples-to-apples. We understand it varies by region, but magnitudes of changes have been fairly similar across regions, and more importantly, the data ties back to what FCA has reported – in contrast to incentives reporting by most trade publications.

  2. Regarding, your Ferrari valuation, did you consider the potential for EBIT margins to increase past 15% in 2016 as shipments increase? It seems the company has a good deal of operating leverage which could boost margins pretty significantly if shipments were to increase.

    1. Todd, thanks for the question. In this analysis posted, we didn’t have substantial growth in Ferrari margins in 2016 because LaFerrari rolls off in 2016, Formula 1 spending ramps up, and we previously weren’t assuming robust volumes growth in the near-term. The Ferrari prospectus says they’d like to build 9k vehicles (up from 7.25k in 2014) in 2019. At an ASP of EUR 240k per car, and incremental margins of 60.8% (from disclosure in the prospectus, we were able to back into the cash incremental margin on vehicle sales), as the company scales up to 9k, incremental EBIT will be approximately EUR 253 million, which would add about EUR 4.6 billion to the incremental value of Ferrari’s equity. So about EUR 2.50 per FCA share (taken at 80% since that’s what FCA shareholders own after the IPO) on top of what we showed here.

  3. Thanks again for the excellent responses! Greatly appreciated. I guess I thought by the 8500k cars or so you had projected in 2016, that EBIT margins would be higher than 15%, even with the LaFerrari roll off and increased Formula 1 spending.

    Thanks again GW, and have a great weekend!

    -Todd

  4. I’m looking ahead to 2017, assuming 8500 cars are sold that year, it would seem to me that EBIT margins will exceed 25%. With those kind of operating margins for a resilient business with pricing power and a huge fan base, valuation should merit the higher end of the multiple range that you’ve set out.

    Any idea what kind of margins the company makes on the engines sold to Maserati and ones that will be sold to Alfa? That could provide further boost to margins (depending on what the margins are on the sales) because the company doesn’t need to scale SG&A + R&D much for increased engine production. Upside from this could be significant if the Giulia turns out to be a home run.

    I’m trying not to get crazy here, but I’m having trouble seeing how Ferrari is not doing over 1 billion in operating income within a couple of years (in which case Ferrari is worth as much as the entire company today). Bring me down to Earth if possible.

    1. TJ – Thanks for the input and comments! We’ve updated our Ferrari numbers since the registration statement has come out. If we back out Formula 1 activities and the Maserati engines out at a single digit margin (still lower scale production ahead of incremental volume from Levante), automotive cash margins are around 60%. So yes, if the company ramps to volumes north of 9k vehicles, EBIT rises above €1 billion just on the automotive deliveries. Engines and licensing could add upside to that.

  5. Hi,

    Any updates to FCAU stub valuation after Ferrari spin off? How does a declining Chinese market and a potential recession affect your valuation ? Besides, analysts keep talking about low margins and high debt. Some of the debt is retired with Ferrari spin off but in a recession how big are these concerns?

    Thanks

    1. Hey Karthik – I’m presenting our updated thoughts on Tuesday, at the Manual of Ideas’ ValueConference. If you’re attending that, you’ll get the update then. Shortly thereafter, we’ll try and update our thoughts in a post. In the mean time to answer your questions – we don’t believe China was ever going to be a huge driver for FCA. Yes, we’ve downgraded our assumptions for China, but with the launch of domestic production of Jeeps and a >5x increase in the total addressable market, they should be able to offset much of the Chinese weakness better than anyone else. Actually, given the Chinese incentives in place, we don’t believe the market will get sloppy in China until late 2016 / 2017. Margins and debt have been the primary concerns at FCA, like you said, and we believe most of the debt goes away by the end of this year, and margins will continue the upward trajectory in North America as incentives come down and key vehicle introductions help take just a slight amount of market share (but more importantly, remove incentives on old vehicles).

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