Fiat - Fix It Again Marchionne (English)

So this is pretty straight forward. In the last 5 years, the company hasn’t generated enough cash to cover the investments it’s made. Yes, it’s become profitable again, but the cash generation has always been weak or non-existent and long term a company can’t function if it doesn’t generate cash. Why not talk about profits, dividends, ROIC, etc? Because if there isn’t any cash flow, all this is simply money lent to shareholders by the creditors.
So the figures are:


In this time period, the company has burnt € 2.1bln of cash including the change in working capital and € 1.4bln without taking into account the change in working capital. What happened? Essentially it seems the investments necessary every year to renew the range of models and conduct research for new models have been too big and aren’t being paid back. On average they’ve invested 6.8% of revenues every year from 2004 to 2008 whilst depreciation and amortisation has been only 5.2% of revenues. 1.6% may not sound like a lot, but when revenues are around € 55bln each year, 1.6% is nearly € 900m.
So how did they manage to improve the net debt position up until 2008? Because of how the Fiat business model works. If Fiat pays its suppliers after 270 days and needs only 60 days to produce a car and sell it, the suppliers are not only supplying the raw materials necessary to make the car, but also the credit that goes towards reducing Fiat’s debt. And when the revenues grow, the trade payables grow faster than the trade receivables creating a virtuous circle. For example, let’s say that I take 100 of raw materials on 1st January to pay within 270 days. 1st March I sell the car for 120. The net cash position is now positive 120 and remains the same for the next 7 months. And if I increase the order for raw materials on 1st March to 200 and sell the 2 cars che I produce on 1st May for 240, I have a net cash position of 360 and trade payables of 300 that I have to pay on 1st October and 1st December have financed my production. If I then stop selling, my net cash position drops to 60 which is the difference between the revenues of 360 (3 times 120) and the costs of 300 (3 times 100). Which is the correct net cash position. It’s important to note that it’s only when the sales drop that the problems become apparent.
And when the economy turns as in 2008 the problems come to light. To go back to the table above, it’s evident that in 2005-2007 the change in working capital reduced the net debt by € 3.5bln, but, when the economy slowed in 2008 and the situation reversed, the net debt increased by nearly € 4bln.
But it’s not just that the business is incapable of producing cash, I believe it’s also following the wrong path with respect to the cars it’s producing. As far as I can make out, the regeneration of Fiat is mainly due to the popularity of the 500. And the man who pushed for the relaunch of this car was Lapo Elkann, who now has nothing to do with the group. Thanks to the 500, Fiat managed to relaunch the brand and get people to identify with a car that seems representative of ‘Italian-ness’. Style, elegance and the fun things in life. More recently we’ve been able to enjoy the launch of the Qubo. I believe the 500 is, or maybe was, the opportunity to sell Fiat cars to the world, but if, after the 500, the range of cars doesn’t remain in keeping with this Italian style, the moment will be lost.
And together with this I don’t understand why at least one of the 3 brands doesn’t get cut to concentrate on Fiat, and maybe one Alfa Romeo car. And why this wasn’t done 3 or 4 years ago. The idea is to produce at most 4 cars that immediately strike you as being Italian. The 500, probably something the same size as a Golf, the Alfa Romeo Spyder and one other. They should all represent style, elegance, the pleasure of life and the way in which Italians do this so simply. To explain this concept, let’s look at how Italians and Americans do coffee. In an Italian bar, you can get an espresso, a cappuccino and maybe a macchiato, but the last one is already a bit extravagant. It’s not like Starbucks where you can get a half-latte, double skinny frappuccino with caramel and it’s going to be just as disgusting as the thousand other choices because fundamentally they don’t understand how to make coffee. Keep It Simple Stupid. Porsche, not by chance, makes a lot of money when it decides to only sell the 911 like it’s done for 30 years. When it decides to start with the Boxster, the Cayman, the Cayenne, the Panamera and then try to buy VW, it all goes wrong. As happened at the end of the 80s with the 924 and the 944. Fiat – 4 cars, Italian, well made, basta. And quit offering a thousand different options.
And Chrysler? At least it’s free. And how much can a free business cost? The time and effort of management for a start. I’ve heard that Mercedes cars went downhill during teh years it had control of Chrysler because they had to send all their engineers over to America to keep an eye on Chrysler and so didn’t have enough talent back in Germany. And Chrysler’s problems aren’t recent and a result of the crisis as Daimler had already started a restructuring plan in 2006 to combat the losses made that year. At a point in time when car sales are being kept at a decent level only thanks to the incentive plans rolled out by various governments my worry is that the force necessary to resolve Chrysler’s problems together with that necessary to resolve Fiat’s is too big and both companies risk being overwhelmed.
So what would be the normal level for sales without the incentives? In America, the replacement rate for cars is estimated to be 12.5mln per year against a rate that’s looks to be averaging around 10mln recently, was 17mln a year a couple of years back and a prediction by Chrysler of sales of 14.5mln in 2014. But, as far as I can see, this presupposes that the banks return to recent lending standards. Which I don’t believe is likely due to the amount of debt still in the system in America or useful given these policies produced the problems we currently see. Chrysler needs to sell 2mln cars per year to breakeven and aims to sell 70% of these in America , or 1.4mln cars. Will Chrysler manage to reach a high enough market share? It currently has less than 9% and, at the risk of looking at the tree rather than the forest, in November, its sales dropped 25%, while Ford’s rose 14% and GM’s dropped 2%. In Italy, group sales (Crysler, Dodge and Jeep) dropped 50% this year. It’s looks to be a difficult task.
And the Italian market? I estimate that the replacement rate is 1.7mln cars per year (current fleet is 34mln, accoridng to UNRAE), whilst the introduction of eco-incentivi meant that 2009 sales are likely to be unchanged with respect to 2008. If 1.7mln is the normal level while the market takes a break, sales in Italy are likely to drop 20-25% when the eco-incentivi stop. As they did in the first few months of 2009. Sales drop this much when the government stops its incentive program because everyone who wants to buy a car does it before the incentive program runs out. For example, in America, sales rose to an annualised level of 14mln in August due to the effect of Cash for Clunkers to then drop in September to around 9mln, below the level of May and June. After a year of eco-incentivi, I expect a period of at least 6 months of weakness in the car market. And what does that mean for Fiat Auto? A year in which margin and sales are likely to be the same as those in the first 3 months of 2009. Sales will drop around 20%, Fiat Auto will have a margin of 0% and the components manufacturing business will be at around -5%.
The value of the business? As long as it’s run like it is now and doesn’t generate any cash, not a lot. It’ll follow the rhythm of the market and then have a capital increase every 6/7 years to make the debt position viable again. And will then burn this cash. I hope we don’t see the 500 become VW’s version of the Mini, but I fear that’s the road we’re heading down at the moment.