|Shares Out. (in M):||1,568||P/E||0||0|
|Market Cap (in $M):||23,143||P/FCF||0||0|
|Net Debt (in $M):||-4,601||EBIT||0||0|
Fiat Chrysler is quickly thrown into the “too hard” bucket by most investors; however, I believe the Ram pickup truck and Jeep Wrangler are high-margin, high return on capital, easy to understand product lines that are less disruptable than the passenger car segment and worth much more than the current enterprise value. Where my writeup will differ from previous VIC writeups on the company is that I’ll primarily focus on these two high-quality assets. I estimate that these two product lines alone produce $5.5B of EBIT, on a total enterprise value of $18.5B (adjusted for the Magneti Marelli sale and assuming a fully funded pension).
That EBIT estimate does not include any earnings from the rest of the Jeep brand which sold ~1.5MM units last year, excluding the Wrangler, with almost no market share in China. While not “great” like Ram and Wrangler, this is still a pretty good business with good global growth prospects, especially given the broader SUV tailwinds. It also doesn’t include any earnings from the Chrysler Pacifica, Maserati, or Alfa Romeo which are decent businesses. Fiat also has a decent business in Brazil with major cost advantages that may one day be worth something.
As a reference point on how cheap the business is including all product lines (not just Ram and Wrangler), managements business plan assumes the company will produce ~$25 billion in cash over the next four years (33% more than the current enterprise value) after spending ~$40 billion on capex (more than 2x the current enterprise value!), and will exit 2022 producing ~50% of the current enterprise value each year in free cash flow.
Pickup Truck Market
The North American pickup truck market can be broken down into three segments: mid-size, light duty, and heavy duty. Light duty and heavy duty are collectively referred to as the full-size market. The U.S. full-size market sold just over 2,400,000 units in 2018, while the mid-size market sold just over 500,000 units. There are another ~400,000 pickup trucks sold in Canada. An important distinction is that while there is a large mid-size market outside of North America, there is virtually no market for full-size pickup trucks outside of North America.
Light duty trucks are primarily used for personal use for people who use them for home improvement projects, hunting, towing boats, sports, etc. ATP in this segment is $41k. Heavy duty trucks are primarily used for commercial purposes in construction, agriculture, and landscaping. ATP in this segment is $53k.
Mid-size trucks are smaller, more fuel efficient, and sold at much lower starting prices (i.e., Chevy Light Duty starts at $28k vs. Chevy Mid-Size at $21k). These trucks are more likely to be an SUV substitute for someone who just likes driving a big car and has an occasional use for the truck bed, but probably isn’t towing anything.
Evidence of a Moat - Stable, High Market Shares (93% Top Three) with High EBIT Margins (~18%)
In the full-size market, the Detroit OEMs control 93% of the market, which is UP from 89% a decade ago despite being an incredibly high margin market. This is clear evidence of sustainable competitive advantages for the Detroit OEMs, which I’ll describe in more detail below.
In the much smaller mid-size market, Toyota actually dominates, with 47% market share. But I believe this is primarily a self-inflicted wound as Ford and Ram haven’t even had products in this segment. Fifteen years ago, this segment was split about evenly by the Ford Ranger, Toyota Tacoma, and Chevy Colorado. However, the market was declining (from ~450,000 units in 2004 to ~163,000 in 2013) due to high gas prices and stale product, so Ford made the decision in 2011 to discontinue the Ranger and allocate the resources elsewhere. It hadn’t been redesigned since 1998 and was bleeding market share. Then GM abandoned the market in 2013 & 2014, leaving Toyota Tacoma as the entire mid-size market. Fast-forward five years and the mid-size market is booming due to a combination of mid-size redesigns by Toyota and GM, low gas prices, and rising full-size prices causing a part of the light duty segment to trade down. The Ford Ranger just relaunched at the end of the year, and Fiat Chrysler will have its first ever mid-size offering in Q2 2019 with the Jeep Gladiator.
None of the OEMs directly disclose their full-size pickup truck margins but GM discloses in its 10-K that “Trucks, crossovers and cars sold currently have a variable profit of approximately 180%, 55%, and 15% of our GMNA portfolio on a weighted-average basis.” Given GMNA margins are ~10%, this implies 18% truck margins, with full-size margins likely higher than mid-size. Ford also discloses that if you remove the bad parts of the business (i.e., passenger cars), “the majority of North America’s business is strong and high performing with an EBIT of $12.5 billion, a margin of 18% and a ROIC of 48%.”
Brand & Domestic Loyal Buyers
Each of the Detroit Three has mid-40% loyalty on their full-size pickups and 71% of full-size buyers have a preference for domestic manufacturers according to a 2018 KBB.com survey. That’s probably because full-size pickup trucks skew geographically to Middle America and buyers are ~90% male and ~75% white.
In the early 1960s, France and West Germany placed tariffs on U.S. chicken imports. The U.S. responded with its own 25% tariff on light trucks, potato starch, dextrin, and brandy. Eventually, the tariffs on potato starch, dextrin, and brandy were lifted, but the light duty tariff has remained in place. Based on the limited success of the domestically produced Toyota Tundra (5% market share) & Nissan Titan (2% market share), I believe this was more important in helping to create domestic dominance and brand loyalty in the full-size pickup market, and less important in sustaining it today. However, it does still help prevent mid-size imports from competing in the U.S. market.
Relatively Small Market Size Makes it Hard to Achieve Economies of Scale
Full-size pickup trucks are a ~2.75MM unit/year market, with almost all of those sold in North America. To put that in perspective, passenger cars are an ~81MM unit/year global market with only about a fifth of those sold in North America. IHS estimated that the top ten auto platforms would produce ~28MM units in 2020. I.e., the top ten auto platforms will each produce a number of passenger vehicles equal to the entire global full-size pickup truck market. The investment required to develop and maintain a pickup truck platform is roughly equal to the investment required for any other platform. With a much smaller market, new competitors need to gain much greater market share in order to spread the large fixed cost of developing a truck platform over a reasonable number of units to be competitive. As far as I know, none of the Detroit OEMs has disclosed how much they spent on their truck redesigns, but the Wall Street Journal stated that an “inside source” pegged the development costs of the new F-Series at a “multi-billion” dollar commitment. And we know Fiat spent $1.5 billion just retooling its Sterling Heights plant to build the new light duty Ram. Hypothetically, let’s assume it costs $2 billion (conservative) to develop a brand-new truck platform that has a five-year life (i.e., $400MM/year amortization). Spreading that out over Ram’s 600,000+ units/year (<$667/unit) is a huge advantage over a new entrant (like the Nissan Titan) that can only spread it out over its 50,000 units ($8,000/unit). In the compact sedan market on the other hand, the vehicle with the tenth greatest market share (<5%), the Audi A3, still sold 290,000 units. The fixed development cost per unit for that platform spread out over 290,000 isn’t that much higher than the first place Toyota Corolla with 1.2 million units, which is why the compact sedan segment, as an example, is much more competitive.
Ram has been competing at a disadvantage for decades due to underinvestment, and in the last half of 2018 just ramped up production of the all new redesigned light duty Ram, which was last redesigned a decade ago. The redesigned heavy duty truck will be ramped up in Q2 of this year. Ford on the other hand redesigned the F-Series in 2015 and Chevy redesigned the Silverado in 2014, and again this year. So for the last three years, RAM has been competing with a truck that was designed five years earlier than its competition. With the new light duty truck fully ramped in Q4 2018 Ram grew its market share to 24.3% and ATPs are closing the gap with Ford. Assuming 24.5% market share, Ram will sell ~670,000 pickup trucks/year. At a $47k ATP with 15% EBIT margins, that’s $4.4 billion of EBIT coming from the Ram full-size pickup business. I believe the RAM full-size pickup truck is worth more than the current enterprise value of $18.5 billion (adjusted for the Magneti Marelli sale and assuming a fully funded pension).
The Jeep Wrangler is in a category of its own; it has no direct competitor and it was just redesigned last year for the first time since 2006. Capacity was also increased from ~240,000 units/year to “well over 400,000 units” if the new model and Jeep Gladiator mid-size truck are “smash hits.” I estimate ~295,000 Wranglers were sold last year (90% in North America), and Sergio Marchionne estimated that the new Wrangler would ramp to ~340,000 units/year with a much larger export business. Margins on the Wrangler have not been disclosed, but Marchionne gave some clues in the past and given the lack of competition, they are surely very high. Marchionne said on the Q4 2017 call that 100,000 Wranglers are equivalent to 160,000 Grand Cherokees or 300,000 Cherokees. He also said, in Q4 2016, that the new Wrangler would be responsible for about $1.7 billion in incremental EBITDA. On 340,000 units (his expectation), that would be $5,000/unit EBITDA over and above the existing profitability of the old Wrangler. Those are very healthy margins on a $35,000 ATP vehicle. I think 10% EBIT margins is a very conservative estimate for the Wrangler, which would mean the Wrangler, at 340,000 units, will produce at least $1.1 billion of EBIT.
The Wrangler will get its first true competitor in 2020 with the relaunch of the Ford Bronco, but that car will not have nearly the brand loyalty of the Wrangler and last year’s 295,000/unit volume does not include any Gladiator sales. Gladiator and Wrangler will be interchangeable on the production line and the Gladiator is a white space mid-size pickup truck targeting a 525,000-unit/year market with only three other real competitors. I expect the Gladiator to sell incredibly well; it looks amazing and will be the only open-air pickup truck on the market. Wrangler also has minimal sales in China and would be a major beneficiary of any future reduction in Chinese auto tariffs which is a possible outcome of a US trade deal.
Self-Driving Disruption / Peak Auto Concerns Less Relevant for Ram & Wrangler
I believe auto stocks trade at such low multiples for two primary reasons: (1) threat of autonomous vehicles and (2) peak cycle concerns.
Regarding (1), I believe the fears of autonomous taxi fleets at scale in major markets are justified in the passenger car and SUV markets. I believe they will arrive sooner than most people expect, eventually causing a major reduction in demand for automobiles since most vehicles are idle 95% of the time. It would be putting it mildly to say that industries with large fixed costs don’t do well in periods of large negative demand shocks. However, I think the market least likely to be disrupted is the full-size pickup truck market for a few reasons. First, the use cases are more than just transportation. Trucks are used in commercial applications, used to store tools, used on camping trips, used to haul boats, etc. Many of these uses cases don’t just require transportation to the destination, but also access to the truck at the destination. Trucks also drive in a lot of places that are harder to program for full self-driving, like construction sites and off-road. Truck buyers also skew to much more rural areas. At the extremes, trucks make up nearly 1 out of every 4 vehicles sold in the Dakotas, but 1 out of every 100 vehicles sold in Washington D.C. and 1 out of every 18 vehicles in California. The last place self-driving cars will arrive is South Dakota (sorry to offend any South Dakotan VIC members). It’s going to take a tremendous amount of capital and time to saturate cities first before the technology makes it out to rural areas. I don’t mean to imply this will never be a threat to pick-up trucks, just that this segment will be the last impacted and at 3.4x Ram/Wrangler EBIT, it won’t happen in a time frame that creates downside from here.
Regarding (2), I believe peak cycle concerns are not valid in the pickup truck and Wrangler product lines. Full-size pickup trucks are generally correlated to housing starts, which are still well below normal. Housing is likely to be a tailwind for the truck market. The pickup truck parc has also aged twice as much as the passenger car parc since 2008. And RAM is likely to be a market share gainer given that its finally competing with a fresh product line which mitigates any potential downside in the market size. This segment is also likely to be much more rational from a pricing perspective in a downturn as it’s so consolidated. The Wrangler is also unlikely to be “peaking” anytime soon. It’s been producing around 240,000 units for the past five years with only 10-15% of that coming from outside of North America due to supply constraints. I think there is pent up international demand for the Wrangler that can cushion any reduced demand in North America.
Proceed with Caution When Valuing Auto’s on SoTP
SoTP valuations on auto companies are a little disingenuous. In the 15% EBIT margin for trucks there is an allocation for general R&D on engine technologies, overhead, etc. As a stand-alone entity, Ram would certainly have lower margins than as a part of FCAU. In the case of FCAU though, I think it’s a reasonable valuation methodology for two reasons: (1) there isn’t that much overlap in the overhead for the truck and car businesses and (2) there has been a “for sale” sign on FCAU for years and any buyer, whether that’s GM, VW, Hyundai, Great Wall, Geely Group, etc., would already have the same overhead in place.
But to be clear, this isn’t just a sum of the parts thesis. This business is valuable in its current form, and MUCH more valuable to an acquirer that could extract massive synergies (Marchionne’s estimates were $3-5 billion/year). I’m simply breaking the business into pieces to show that enough of the business is high-quality and understandable to create a floor value that’s much higher than the current price, making certainty on what happens five years from now on the remainder of the business unimportant.
NOTE: FactSet’s share count is 26% higher than the actual share count because they include loyalty shares that have a voting impact but immaterial economics. I’m not sure if Capital IQ has the same issue; I don’t think Bloomberg does.
M&A, Ram market share gains, Wrangler growth, Ram spin-off, Finco, China growth, Maserati/Alfa success.