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Toro Italiano
While we love to shy away from talking macro, the Italian economy has undeniably turned the corner with its foot on the gas. We’re very well positioned for the renaissance.
Speed Read:
- We’re Italian Bulls: early cycle industries are improving even further in the third quarter
- Italian consumer confidence at a 13-year high
- Fiat-Chrysler: Italian auto sales now pulling the European average up – FCA’s taking market share in Europe
- Piaggio: Italian scooter sales (which are down >60% from the highs) have begun a very earnest recovery
- Fiat-Chrysler: A study published this past week adds to our previous argument that Fiat hasn’t been “gaming,” its emissions statistics, as its real-world vehicles tested fairly similarly to the lab results
- Finmeccanica CEO delivers – both results (1.5 years ahead of plan right now), and a major order with the Kuwait government
Toro Italiano
Got that sinking feeling about U.S. markets and the economy? Many people we know feel that way nearly all of the time. We think it’s probably a structural phenomenon because bad news sells and travels much quicker than good news. When asked to give an impression about the economy or markets, availability biases often lead us to answer these questions negatively, as we’ve often heard more negative than positive headlines.
But we postulate that no one, not even the Federal Reserve, can predict macroeconomic variables with any certainty. Hundreds, if not thousands of estimates go into large economic calculations, and each of these will be estimated with a 95% confidence level, at best. Multiplying one hundred economic inputs together at a 95% confidence level into a single statistic (like GDP) means that we end up with a calculation that gives us a 0.006% chance of being accurate (calculation = .95^100).
Even still, we’ll break with tradition as the news and data coming out of Italy lately have been overwhelmingly positive, after nearly a decade of stagnant economic growth. Yet, even with the economic recovery fully underway, global markets selling off have created a truly unique investment opportunity, with very low valuations and significant expansion potential in the near-term, giving us fantastic risk-adjusted return prospects in many of our names. Our portfolio’s risk-adjusted return profile at the end of September reached new peaks, with a ratio of over 30 to 1.
We’ve been bullish on the prospects for the Italian economy and some of its companies for over a year now, despite ongoing pessimism about the country which has seen the economy shrink nearly 10% since early 2008. Economists were recently disappointed by the 0.3% growth in the eurozone’s economy in the second quarter, and while they may have been expecting faster growth out of Italy, the early cyclical indicators we care most about have shown a nice pickup in the third quarter. Italy’s prolonged depression has led to manufacturers and companies under-investing in the economy to weather this storm and it has created a significant amount of pent-up demand for discretionary purchases, such as automobiles and scooters. This low tide has decidedly turned.
Exhibit 1: Changes in Italian GDP
Consumer confidence has rebounded significantly, and is now higher than it was before the economy contracted 10%. September’s reading of 112.7 is a 13-year high. Confidence typically is a leading indicator, and early discretionary purchases like automobiles have typically followed. Scooter sales have typically had an even greater lag to confidence than auto sales have in Italy. Italian auto sales turned positive in December of 2013, nine months after the bottoming of consumer confidence. Fiat-Chrysler has a great product refreshment roadmap which began a few quarters ago. Accordingly, FCA is growing even faster than the Italian market, and is taking market share in most European countries, which are largely also improving.
Exhibit 2: Italian Consumer Confidence & Auto Sales
Thanks to Italian auto sales performing at the top end of the individual European country performance, Italy’s share of the European market has started to increase after years of consistent declines. Given FCA has a ~30% share of this important market (contrasted to only 6.3% of the total European passenger car market), the automaker will be one of the top-performing automakers in the recovery.
Exhibit 3: Italian Share of the European Passenger Auto Market
FCA is poised to build on this market share grab in the wake of the Volkswagen emissions scandal. A study published this past week by the European Federation for Transport and Environment confirms that all evidence points to Fiat-Chrysler as being among the lowest-risk automakers of having used test-cheating devices. As exhibit 4 shows, the both FCA and Toyota had real world tests produce similar results to the laboratory tests used to certify its vehicles on the road. This ignores the fact that Fiat has the cleanest cars on the road in Europe to begin with. As we detailed last week, FCA’s shares are cheaper than Volkswagen’s, backing out the value of Ferrari – which begins its IPO process this week. FCA shares represent an outstanding opportunity, and Italian auto sales have staged a significant recovery, adding to this momentum.
Exhibit 4: Real World Emissions vs. Lab Tests
Two-wheeler sales have taken longer to recover after an even more brutal fall of 69% over the last fifteen years (compared to a 46% decline in auto sales over the same period). Yet, in the most recent year, scooter sales stopped declining and started expanding again, albeit modestly. In July and August, however, the recovery has accelerated and the replacement cycle for Europe’s oldest fleet of two-wheelers has begun. For most of the last 15 years, Italy was the largest market for two-wheelers in Europe. Yet given the incredible near 70% decline in scooter sales during this period, France briefly became the most important European market.
Exhibit 5: Key European Scooter Sales (Indexed)
Italy is back on top thus far in 2015, as consumers begin refreshing an unprecedentedly old fleet of two-wheelers. Piaggio’s namesake brand, as well as the Vespa brand, stand at the center of this recovery with some important new model introductions later this year and early next year. Yet, we are buying the current stock at a discount to its historical trading value and far below its take-out valuation (Daimler is notably absent from the two-wheeler market despite Volkswagen and BMW both increasing their presence in this space in the last decade). We’ll write more on Piaggio later this quarter in The Grove.
Exhibit 6: 2015 Italian Scooter Sales
In other Italian news, Finmeccanica, which has been outperforming the guidance it gave us only 6 months ago, has delivered for the EuroFighter consortium. Kuwait signed a major order for EuroFighter typhoons – helping extend the runway of production that was going to wind down in 2017-2018 timeframe. The group of companies producing the Typhoon fighter jet, which includes FNC’s Alenia Aermacchi and BAE Aerosystems on the airframe as well as Rolls Royce and MTU Aero Engines for the propulsion, will all benefit from the order, but because it is Finmeccanica’s first major negotiated export transaction for the Typhoon, it will receive a more generous share of the €7-8 billion order. We estimate this single order could increase Finmeccanica’s backlog by over 20%.
This is one of many positive developments at Finmeccanica since we’ve invested in the shares. The company is progressing on its wide-ranging restructuring plan, which is filled with low-hanging fruit. Despite being in the “early innings” of its restructuring plan, as characterized by the company last week, cost cutting has helped improve the company’s trailing operating income to nearly the 2016 levels it has promised investors. Much depends on the important back half of this year, but early results have shown just how massive the upside potential is for Finmeccanica as it recovers from over a decade of mismanagement.
All of this momentum coming out of Italy (49.5% of our invested assets) drove the risk-adjusted return profile of our portfolio at month-end to over 30x. Using today’s prices, which have staged a significant recovery since then, our risk-adjusted return profile is still 25x. We’ve never been more optimistic about our prospects in this quickly and dynamically-changing world.
“If things seem under control, you are just not going fast enough.” -Mario Andretti
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.
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