Seeking Alpha
Growth at reasonable price, long-term horizon, research analyst, investment advisor
Profile| Send Message|
( followers)  

Introduction

In this article, I intend to explain my view about Peugeot's (OTCPK:PEUGF) future. The company is going through a capital increase, where the French State and the Chinese manufacturer Dongfeng are going to become important shareholders. The depressed European automobile market has been a tough challenge for Peugeot, a company that traditionally relies heavily on this market.

Graph 1: Car sales by geography in 2013 (source: PSA)

(click to enlarge)

The lower sales had a huge impact due to the rigid cost structure of the company. This led to operating losses, which resulted in a potentially problematic balance sheet. Those facts were broadly responsible for depreciation in the stock price, around 60% since the end of 2010.

Graph 2: Stock price (USD) evolution in the 2013 - 2011 period (Source: Google Finance)

(click to enlarge)

Two problems: Sales and Operations

The first problem stemming from the lower sales is Peugeot's bad cost structure. Let's compare Peugeot's cost structure with Ford (NYSE:F) and Renault (OTC:RNSDF):

Table 1: Standardized cost structure (Data: average 2013-2011, Source: Reuters)

Renault has the best streamlined operation, with the least cost of revenues of the 3 companies. In terms of recurrent operating costs, Renault has the highest costs, but Peugeot is not far. Ford on the other hand, benefits a lot from scale economies, being able to keep the recurrent operating costs significantly lower than its peers. At this point, Ford is the best performer, while Peugeot is the worst. In the non-recurrent costs segment, Peugeot again performs badly. The write-down that the company posted in 2012 weighs a lot in this analysis.

In the financial costs segment, Renault benefits from the equity earnings in Nissan, while Ford seems to have a good financial operation in place, which results in gains. Peugeot, again, is the worst of the three companies.

Just a final note to the tax benefits earned by Ford, don't be fooled, since those benefits should disappear in the future, if the company keeps the good results.

So, Peugeot needs to streamline in almost every segment that we have analyzed. The cost of revenues should be pushed closer to Renault's level, while some streamlining in the recurrent operating costs would be welcomed. The non-recurrent costs shouldn't be a problem, after a € 4 billion (USD 5.5 Billion) write-down, most of the asset revaluation should be done by now. Also, a better hold in the financial operations of the company would be welcomed.

The second problem is the impact of 3 years of struggling operations on the health of the balance sheet. Let's check some balance sheet ratios for Peugeot, Ford and Renault:

Table 2: Balance sheet ratios for Peugeot, Renault and Ford (Data: 2013)

Peugeot's short-term financial resources were stretched to the maximum, the acid test tells us that if some short-term liquidity problem arises, Peugeot might not have sufficient cash to overcome it. The debt and leverage are high but not far from Ford's levels. In my opinion, the short-term liquidity is a problem and must be addressed.

Two Solutions: China and a revamped Management

The first thing that reassures me about Peugeot's fate, is the fact that the board of directors is being proactive in managing this crisis. The public information indicates that the board is well aware of the problems that are affecting the company. Therefore, it seems to me that Peugeot's board is looking for more than simply solving a liquidity problem. They reviewed the company's situation and designed a plan addressing not only the short-term liquidity threats but also other frailties. I think that the board of directors knows that it should have reduced Peugeot's dependence on the European market long ago. On the same note, the directors know that Peugeot wasn't successful in penetrating the Chinese market. The company holds a mere 3.5% market share in the country. Therefore, I see the capital raise as a shortcut to achieve some interesting results sooner than could be expectable: A solid foothold in the Chinese market, through a partnership with an incumbent producer. A new power balance between the largest shareholders: Peugeot family, French State and Dongfeng, each owning 14% of the total stock. Finally, the fresh capital will assure most of the stakeholders that the company has a future.

Graph 3: € 3 Billion (USD 4.1 Billion) Capital Increase (source: PSA)

(click to enlarge)

Some analysts agree with the idea that the capital increase should be enough to create a robust balance sheet that will be essential for the turnaround to be executed in the next two years. (Source: Moody's).

Table 3: Balance sheet after the capital increase (rough estimation)

Clearly, this revamped balance sheet increases the cushion margin in case of unforeseen events negatively impacting the company's restructuring, in the following two years.

On the other hand, a revamped management team should help in addressing some operating challenges. Some analysts defend that Carlos Tavares is the right man to be at the helm of Peugeot (source: Automotive News Europe). The former number two at Renault is regarded as capable of achieving significant savings through tight supplier deals, streamlined logistics and redesigned production operations. This could have a positive impact in the company's cost of revenue, recurrent operating costs and avoiding more asset write-downs. In the financial operations front, the deal with Santander Bank to form a Joint venture with PSA to run Bank PSA Finance could be a serious boost in bringing more efficiency, while at the same time frees up capital (Source: WSJ).

Investment Case For Peugeot

Let's now see how this translates into an investment case for Peugeot. In my opinion, the downside is the company failing to materialize the turnaround, during the following two years. This would lead to new write-downs, in this case the stock price would most probably fall back to the 2012 levels, around 6€ (around USD 8.20), or a loss around 50%.

In the case of a successful turnaround (let's call it successful, in the shareholders' perspective, if the company is able to create earnings' power around € 2,000 Million or USD 2,800 Million), even with the dilution provoked by the capital increase, the returns would be very interesting:

Table 4: Financial figures for the successful turnaround scenario (estimations)

Please note in the capital increase, there will be a distribution of one warrant for each share to the current shareholders, where each 10 warrants convert to 3 shares with an exercise price of € 7.5 (approximately USD 10.28)(Graph3). This explains the P&L Adjusted line in table 4.

My opinion is that the upside scenario offers good returns and has a fair probability of materializing. Now it is up to the prospective investor to assess the feasibility of the scenario presented in this article.

Note: The previous article is solely the view of the author, based on public information and conjectures based on his experience and technical knowledge. It should not be interpreted as an individual buy or sell recommendation. This article might be subject to differences in the interpretation of the publicly available information and future developments.

Final note: The figures in USD are purely indicative.

Source: An Investment Case For Peugeot