A Call On The European Car Industry: Long Peugeot, Short Fiat

| About: Peugeot S.A. (PEUGF)
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How to get exposed to a recovery of European car industry? Be long Peugeot, short Fiat.

Peugeot's new "ticket," with Tavares as CEO and Gallois as chairman, is very promising.

Product lineup is far richer at Peugeot than at Fiat.

Geo mix: A call option on China for Peugeot, vs. U.S. exposure for Fiat.

Valuation: Two cash-burning companies, but Peugeot looks cheaper on multiples.

A lot is happening in the European car industry today. The outlook is improving after several years of decline, but mass-market European players still look quite shaky (despite share price having almost double last year)… In this context, we feel there is still some money to make but the best strategy is a relative value play: our call is to go long Peugeot (OTCPK:PEUGF) and short Fiat (FIADF).

At first glance, Peugeot and Fiat have a similar profile: century-old family businesses, European-centric, mass-market car makers, with low volumes compared to world leaders (less than 3m for Peugeot and a bit more than 4m for Fiat), Peugeot and Fiat were both severely hit by the crisis in 2008, and both burnt billions of euros of cash.

But Peugeot and Fiat took very different paths to survive the crisis. On one hand, Peugeot went for a massive € 3bn share issue (to take place before summer), with, at the end, three major shareholders having each 14% of the capital and voting rights: the family, the French state (oops!) and Dongfeng Motors. So to sum up: fresh cash, a window on China, but three different key shareholders and still the same low volumes. On the other hand, Fiat answer to the crisis was to swallow Chrysler: so, bigger volumes, but huge pile of debt (€ 12bn; USD 17bn) and material execution risks on the merger of Fiat and Chrysler (remember Daimler-Chrysler…).

Analyzing key topics which are management/governance, product lineup/ability to innovate, geographical mix (both on production capacity and sales), cash-flow and valuation, we feel Peugeot strategy is more likely to deliver strong positive results than Fiat one. Hence our call of long Peugeot / short Fiat.

Management and governance

Peugeot: new management and renewed board of directors! The new CEO is a French-Portuguese "car guy" Carlos Tavares. He is an engineer, former n°2 of Renault-Nissan, where he has spent his entire career, and finally left last year after having told in a Bloomberg interview that he had "the energy and appetite for an n°1 position but Renault has a big leader and he is here to stay"... Peugeot employees are definitively delighted to have a car guy heading the company, after a string of outside managers in the last ten years. He is clearly the man for the job.

The board of directors is another story: following the share issue, the board will not anymore be controlled by the family (good point), but will have 14 members, of which 2 from the family, 2 from Dongfeng, and 2 representing the French state. Is it that negative to have the French state on board? Well, there are a string of companies where the French state has a significant share of capital and are doing great job: Orange (telecoms), Airbus Group, Renault … And having the family less influent in the company is quite positive in my opinion… Ice on the cake: new appointed chairman is a veteran of French industry, very well regarded: Louis Gallois.

Fiat: Sergio Marchionne, CEO of Fiat, has also a very strong reputation in the car industry. He has been heading Fiat for the last 10 years. Fiat was is 1st job in the auto sector. Fiat Board of Directors is still controlled by the Agnelli family. So no catalyst (neither positive nor negative) for Fiat.

Product lineup and innovation

Peugeot: despite the crisis, Peugeot didn't give up investing in innovation (until last year at least) and kept excellent quality cars. Two quick examples: (NYSE:I) Peugeot developed a state-of-the-art hybrid engine: the Hybrid Air. This technology will be fitted on B-segment models starting in 2016. (ii) Peugeot 308 was elected Car of the Year at the last Geneva show, other nominees were, for instance, Tesla S, BMW i3 or Mercedes S-Class. The € 3bn share issue will secure a strong Capex level for the next years. One target of Tavares would be more to rationalize the numbers of models to focus on the "blockbusters" and differentiate the three brands (Peugeot, Citroen, DS).

Fiat: since 2007, Fiat product line up is heavily centered on the Fiat 500 and all its derivatives (500L, 500Living, 500X…). It is a success based on marketing, rather than innovation. As far as Chrysler is concerned, the fact the company was under Chapter 11 in 2009 amidst the crisis didn't help to develop new cars and innovate (Chrysler has though recently launched new models). Lastly, the necessity to deleverage and generate cash should weigh on future Capex.

Production and revenues geographical mix

The two car makers face the same problem in Europe, with too many capacities and too low revenues. Fiat answer is basically to specialize Italian capacities on luxury and performance brands (Maserati, Ferrari…). Peugeot closed some capacities (e.g. Aulnay in France) in Europe, but the utilization rate is still low (~75% last year) in the absence of a rebound of sales in Europe. The deal with Dongfeng will not prevent Peugeot from solving this issue as we don't imagine Peugeot manufacturing cars in Europe to be exported to China! So a lot is expected from Carlos Tavares to rationalize the production capacities. He is viewed as a cost cutting, cold-hand guy able to do this kind of restructuring, even if, at least, for France, he will have to deal with French state (note that Renault where the State is a key shareholder has far less capacities in France than Peugeot).

On geo mix and volumes, Fiat/Chrysler sell more than 4 millions cars a year with a strong foothold in the 2nd market in the world, the US. But Peugeot, with ~2.5 million cars sold, mainly in Europe, is betting heavily on China, with the partnership with Dongfeng, where they expected to triple sales to 1.5 million by 2020.

Cash flow and valuation

On cash-flow, both have burnt billions of € of cash-flow in the last 5 years. Both are expecting positive free cash-flow by 2016. On multiples, Peugeot looks a bit cheaper (EV/sales 15e: 18% vs. 33% for Fiat and EV/EBITDA 15e of 3x for Peugeot and 3.3x for Fiat). Fiat geo mix (US/Europe) calls for higher multiples although huge debt pile (in excess of € 11bn) should weigh on valuation.

Risks to our call

Peugeot (on the downside):

  • failure to increase volumes in China at the expected level
  • failure to achieve positive FCF in 2015/16
  • failure to rationalize capacity and volumes in Europe
  • Board split between French state, family; Dongfeng

Fiat (on the upside):

  • Chrysler / Fiat integration delivers higher and quicker synergies than expected
  • IPO of the on luxury and performance brands (Ferrari / Maserati) on high multiples
  • a better-than-expected product line up/ positive free cash-flow earlier than expected.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.