Dec 20 - Fitch Ratings says that another year of new vehicle sales decline in Europe in 2013 combined with an adverse pricing environment will put further pressure on European car manufacturers’ revenues and operating margins. The negative impact on profitability and cash generation from top line erosion will also be exacerbated by most carmakers’ continuously poor cost structure, including low capacity utilisation rates.
A series of recent investor meetings with Fitch’s EMEA and US automotive teams in New York, Boston, Paris, London and Frankfurt underlined investor concerns about these and other issues. Investors seem most concerned about the likelihood for a sixth consecutive year of sales decline in Europe and about Fitch’s assumption that a recovery in new vehicle sales back to 2007 levels could be as far away as the end of the decade, if ever.
Fitch’s current base case for new vehicle sales in 2013 is an approximately 3% decline following an already material 8% decrease expected in 2012. This would mean a 23% fall since 2007. In addition, pressure on new car prices remains intense. While aggressive pricing conditions were mostly a concern for mass-market manufacturers in the past couple of years, there is increasing evidence and comments about premium brands also suffering. It is a recurring but increasing issue in Europe, where manufacturers fight to at least maintain market share in a context of falling sales.
Investors were particularly concerned about Peugeot SA’s (PSA, ‘BB-'/Negative) and Fiat Spa’s (‘BB’/Negative) ratings in this adverse environment. Fitch believes that these two companies are the most weakly positioned in Europe and that pressure is building on their current ratings. In particular, in line with Fitch’s assumptions, investors were concerned about PSA’s ability to revert to positive free cash flow (FCF) generation in 2015 and Fiat’s ability to reach breakeven in Europe and access Chrysler’s cash.
The agency believes that its current base case for PSA of a negative FCF of up to 5% in 2012 and 2013 could worsen to high single digits in case of a combination of several adverse factors, including sales falling by more than 3% in Europe, a higher-than-expected slowdown in emerging markets such as China and Latin America and a deteriorating pricing environment in Europe, notably on recently-launched models. This would increase the similarities with General Motors in 2008-2009 and could lead to a downgrade to the ‘B’ rating category. For further details on how PSA and Fiat compare with General Motors and Ford in 2005-2008, please see Fitch’s special report “Fiat and PSA Compared With Ford and GM in 2005-2008”, dated September 2012 and available at fitchratings.com.
Potential state interference with PSA’s ability to implement its strategy fully independently was also on investors’ minds as the group received a state guarantee for up to EUR7bn on debt to be issued by its captive finance subsidiary Banque PSA Finance (BPF). Fitch believes that possible state meddling remains a possibility and that some future restructuring actions may be reduced by the state as an indirect payback for the BPF guarantee. However, the agency sees this guarantee positively overall as it will enhance the group’s ability to refinance its dealers and customers, and believes that the recent restructuring actions announced will go ahead.
Fitch’s concerns on Fiat focus on its profitability and cash generation on a standalone basis as its access to Chrysler’s cash is limited by a strict ring-fencing. In addition, the group’s recently announced revised strategy to reposition its brands more upscale makes sense according to Fitch but carries substantial execution risk, particularly in the current extremely difficult competitive environment where other companies have followed the same route, and given the group’s poor track record in its previous attempts to do so. Cash absorption from underlying operations is a particular concern as this strategy entails an acceleration of capex and R&D expenses in the next couple of years. Similar to PSA, higher deterioration of sales and pricing in Europe could lead to a downgrade.