By Daniel Hunter
Fitch Ratings says that European auto manufacturers seem to be taking different approaches to prepare for what should be further deteriorating market conditions in Europe in 2013.
However, despite the apparent differences, the recent strategic announcements all boil down to eventually concentrating manufacturers' efforts on investment or making sure they can continue funding capex and R&D if underlying cash from operations weaken.
Fiat Spa ('BB'/Negative) and Volkswagen AG ('A-'/Positive) announced increased or accelerated investment in the next two to three years, which will lead to higher cash outflows. Three other manufacturers, Daimler AG ('A-'/Stable), Peugeot SA (PSA, 'BB-'/Negative) and Renault SA ('BB+'/Stable), have gone in what looks like the opposite direction having recently sold non-core assets and bolstered their balance sheet through material cash inflows.
However, Daimler and Renault have more headroom in their financial profiles than PSA and will be able to reinvest the proceeds of the asset sales in their automotive operations, hence enhancing growth opportunities, rather than absorbing materially negative funds from operations (FFO). Alternatively, asset disposals can also ensure that investment will not be reduced if earnings and FFO are significantly hit by worsening market conditions.
In December 2012, Daimler sold a 7.5% stake in EADS for EUR1.7bn, and Renault disposed of its remaining 6.5% participation in AB Volvo ('BBB'/Stable) for EUR1.5bn. As part of its overall EUR1.5bn asset sale programme, including real estate and other assets, PSA sold a 75% stake in its logistics division Gefco for EUR800m and a EUR100m special dividend.
Fitch views positively the disposal of non-core assets which do not structurally and materially enhance group's earnings and cash generation. In particular, Daimler's stake in EADS did not provide any substantial financial interest to the group whereas dividends received from Volvo, albeit positive for Renault, were not pivotal to the latter's free cash flow.
However, the majority sale of Gefco will deprive PSA of Gefco's recurring funds from operations and reduce its profitability in the future. Gefco's operating margins were 5.9% in 2011 and 3.3% in H112, much higher than PSA's overall industrial margins of 1.4% and negative 0.9%, respectively. Nonetheless, Fitch acknowledges that this disposal bolsters the group's liquidity at a time where it needs it critically to offset cash absorption and losses from its underlying automotive business (negative operating margins of 0.2% in 2011 and 3.3% in H112).
Likewise, Fitch assesses differently Volkswagen's and Fiat's announcements to accelerate their capex and R&D programmes. While this plan should benefit Volkswagen, increasing cash outflows could put further pressure on Fiat given the limited headroom in its current ratings. Volkswagen is boosting its already broad and successful product range and strengthening further its dominant positions and market shares in Europe and other international markets.
Conversely, Fiat's increased spending addresses years of underinvestment and the group's revised strategy to reposition its brands more upscale. While Fitch believes that this strategy makes sense, it carries substantial execution risk, particularly in the current extremely difficult competitive environment where other companies follow the same route, and given the group's poor track record in its previous attempts to do so.
Free cash flow generation will be a critical rating factor in 2013 for auto manufacturers, particularly the most weakly positioned companies, Fiat and PSA. Fitch is concerned that its current base case for cash generation through 2014 may be reviewed downwards if the environment deteriorates more rapidly than its current projections.
In particular, Fitch expects sales to decrease by a further 2%-3% in Europe in 2013 - the sixth consecutive year of decline - and the pricing environment to remain challenging. Higher than expected cash flow deterioration would in turn have a negative impact on these groups' credit profiles and ratings.
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