About: Fiat Chrysler Automobiles NV (FCAU), Includes: F, GM
Summary
Analysts still do not believe that Fiat Chrysler will hit its 2018 business plan targets despite the fact that the company has consistently over-delivered on the plan.
Fiat Chrysler is one of the cheapest automakers, yet has the clearest path to improve profitability and is led by the best management team in the industry.
We believe a significant stock re-rating will occur when Fiat Chrysler turns to a net cash position in 12 to 24 months.
Despite the recent rally in the share price, Fiat Chrysler Automobiles (NYSE:FCAU) still offers investors a very compelling opportunity with potential upside of 100%-200% within the next 2 years, while at the same time providing a limited downside due to cheap valuation that already bakes in a recession.
Company presentation and current situation
The company is misunderstood and has been neglected for years by financial analysts who saw in Fiat Chrysler an inefficient European automobiles manufacturer, drowning in debt and over-exposed to poorly performing European markets or to emerging markets with economic difficulties.
We instead believe that Fiat Chrysler is (and has been since the Chrysler takeover) a fantastic special situation, led by the best management in the industry. Following the Chrysler takeover (bought by management basically for free, at 1x FCF), the company has transformed into a global player with various levers to improve the bottom line.
Sergio Marchionne presented a comprehensive 2014-2018 business plan that has always been considered as too ambitious and unachievable by analysts. Yet, 3 years later, the company has consistently executed on the plan, beating consensus at each publication and even raising its already ambitious financial targets.
Strategy, management and progress to date
Under Sergio Marchionne's leadership, and following the Chrysler takeover, Fiat Chrysler has developed clear initiatives to transform into an efficient and global automaker:
- Develop premium and luxury brands Alfa Romeo and Maserati. This helps the company's margin expansion not only by selling higher-margin products, but also by gaining efficiency as these brands will use excess production capacity in European plants. So far, this has been a success as Maserati is now highly profitable and Alfa Romeo expanded its product line and now competes in key market segments.
- Expand sales of existing brands into new markets, particularly by globalizing Jeep and Alfa Romeo. The globalization of Jeep has delivered impressive results, with the brand showing exceptional sales growth.
- Develop platforms and rationalize vehicle architectures and standardize components.
- Focus on cost efficiencies.
All these initiative having the same common goal of expanding margins and improving capital structure.
We also think it is important to stress that Sergio Marchionne is, in our opinion, the best CEO in the industry, with a clear focus on ROIC and performing exceptionally at capital allocation while also being a great operator. He has underlined at several occasions the need of consolidation in the automobile industry (e.g., in his "Confessions of a Capital Junkie" presentation) to achieve better efficiencies and stop the waste of capital to develop similar architectures and systems - a view we share with him, and frankly are quite puzzled that no other auto CEOs seem to agree with him.
Since taking over Chrysler, the company has achieved some impressive results and generated significant value for its shareholders:
- Top-line and bottom-line have both been growing at a fast clip over the past few years, executing on the strategic pillars mentioned above.
- The elimination of the Chrysler's debt ring-fencing provided the company with significant liquidity and lower interest expense.
- Ferrari has been spun-off to generate cash (holding it has rewarded investors well as the decision to increase the production limit of its luxury products generated incremental earnings with almost no additional investments).
- Net debt has recently been significantly reduced.
Despite all of these moves, there is still significant value to be unlocked, for instance, through the sale of the auto parts business, Magneti Marelli. While the plan laid out by Marchionne necessitated heavy investments to refresh existing products and enter new segments, the company's peak in capex is now behind it and investments should significantly be reduced in the next 2 years, allowing the company to generate some $10 billion in free cash flow.
Valuation
Investors are currently paying 6x 2016 EPS and 2x 2018e EPS for Fiat Chrysler. We acknowledge that automobile is a no-moat, capital-intensive industry; yet we do not believe that it makes sense to value automobile manufacturers as if they were going bankrupt - especially best-in-class ones.
Part of the reason for this low valuation is that analysts are worried about (1) the level of debt of the company (which we will develop later), and (2) peak SAAR in the US.
