- Investors gave little credit yesterday to Fiat’s 2018 targets: the group plans notably to increase its net income to around EUR5bn in 2018 from EUR0.9bn in 2013.
- They also remained concerned about the group’s balance sheet.
- But we remain confident that a mix of capital increase, disposals and improving cash generation will gradually reduce the group’s debt and the stock beta and sustain the rerating.
- Even assuming a 30% miss on 2018 targets and a capital increase, the stock’s 2018 P/E would be cheap around 3.5x.
Little confidence in the 2018 targets and in the financial deleveraging
Fiat's (OTCPK:FIATY) 5-year plan is obviously ambitious (revenues expected to rocket 50% by 2018, EBIT margin to almost double) and illustrates CEO Marchionne's determination to extract synergies from the full merger with Chrysler, which have been pretty limited until now as Fiat owned only 58.5% of Chrysler.
Unfortunately, the plan's announcement was overshadowed by:
1. A poor Q1 with trading profit missing expectations by c.20%, raising concerns about the group's ability to reach its aggressive 2018 targets if 2014 proves weaker than expected.
2. A still unclear stance regarding Fiat's short-term financial deleveraging. The group, which has a EUR10bn net debt in line with its market cap, was widely expected to launch a convertible bond issue or a capital increase…but did not announce anything.
We understand yesterday's negative price reaction, notably in view of the stock price rally in recent months. But we believe this could be the opportunity to get (increased) exposure to the stock as the merger benefits will be significant and drive the earnings much higher (even if you do not believe in 2018 targets) and as the valuation would remain cheap even assuming a EUR3-4bn capital increase.
Some short-term business disruption is likely, but this should not overshadow the long-term merger benefits
As for Q1 earnings, Fiat was affected by negative prices in North America and by a recall. We also suspect that Fiat is starting to suffer some business disruption in the wake of the Chrysler integration. This could last several quarters but this should not overshadow the significant savings expected from the merger.
Both companies are unsurprisingly expected to extract savings from the combination of their manufacturing operations. But they are also expected to improve their top-line outlook: Chrysler will enhance the distribution of Fiat brands in North America (premium brands such as Alfa Romeo and Maserati) and/or rebrand Fiat models for the North American market. Conversely, Fiat is expected to boost sales of Chrysler models in Europe.
2018 P/E in a 2.5-3.5x range
As for Fiat's financial leverage, we have been saying since 22 January that debt was not a major issue in the currently improving macro environment. The 18 March bond offering of EUR1bn 7-year notes with 4.75% coupons confirmed our view as demand outstripped supply.
Over time, we remain confident that a mix of convertible bonds/capital increase, disposals (potential Ferrari or Maserati IPOs) and improving cash generation will gradually reduce the group's debt (and the stock beta), even if Fiat's cash generation target (debt reduction close to EUR9bn by 2018) appears once again very aggressive.
In all, the deleveraging effort and the beta decline should spark a continued stock rerating.
Fiat targets net income around EUR5bn by 2018. Assuming a 30% miss (hence EUR3.5bn earnings) and a convertible bond / capital increase of EUR3-4bn, the 2018 P/E would stand below 3.5x, which is far from being excessive. If Marchionne delivers on the 2018 targets, the P/E would decline to 2.5x.
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