Fiat Chrysler Automobiles (NYSE:FCAU) reported that its third-quarter profit was up 7.4% over year-ago results, thanks, in large part, to strong sales growth in North America. FCA posted pre-tax earnings of 926 million euros ($1.18 billion), up from 862 million euros in the year-ago quarter, before the bell on Wednesday.
That missed Wall Street's consensus estimate of 937 million euros. But the stock rose sharply on Wednesday, thanks to the biggest news of the morning: FCA plans to spin off Ferrari, its "crown jewel."
Big moves to raise needed capital
The merger of Italy's Fiat S.p.A. with Detroit's Chrysler was finally completed earlier this month. On Wednesday, the new company's board announced several different actions intended to shore up FCA's balance sheet and fund its ambitious five-year plan, including a new convertible debt offering, moves to refinance some of Chrysler's old loans, and the sale of the Ferrari supercar brand.
Sometime next year, Ferrari will be spun off from FCA as a public company, with its stock listed in the U.S. "and possibly a European exchange," according to the announcement. The plan is to distribute 90% of Ferrari's stock to existing FCA shareholders, while offering the remaining 10% to the public via an IPO, likely on the New York Stock Exchange.
CEO Sergio Marchionne has long believed that Ferrari is vastly undervalued as a holding of Fiat. He reiterated on Wednesday that he thinks that Ferrari should be valued as a "true luxury brand" rather than as an automaker, and expects the spinoff of the storied brand -- along with the debt offerings and other moves -- to raise a total of 4 billion euros for FCA.
A closer look under FCA's hood
The news about Ferrari overshadowed FCA's third-quarter results -- but those results are worth some attention. As with other global automakers, the best way to understand FCA's quarterly earnings report is to look at each of its business units in turn, starting with the regional units that sell its mass-market brands.
What FCA calls its "NAFTA" unit made 549 million euros before taxes in the quarter, up just a bit from the 536 million euros it made a year ago -- despite a 21% year-over-year increase in vehicle sales driven by strong results for the Ram pickup and Jeep SUV lines.
Why the small profit gain? As we saw when General Motors and Ford reported last week, increased "warranty and repair costs" related to this year's rash of recalls made a big impact -- about 250 million euros in FCA's case.
But behind the recall costs, the news was pretty good: Strong gains in sales volumes and product "mix" -- the ratio of more-profitable to less-profitable vehicles sold -- combined with some gains in net pricing, more than offset the increased costs. Last quarter, Marchionne said that the NAFTA unit needed to rein in its use of incentives in order to improve margins; it appears to have made significant progress on that front during the third quarter.
NAFTA's operating profit margin was only 4.2%, far behind the North American margins posted by both Ford (7.1%) and General Motors (9.5%), and down from the 4.8% it managed a year ago. But if the recall costs were excluded, the unit's margin would have been a more respectable 6.1%.
FCA's U.S. dealer inventories stood at 71 days' supply as of the end of the third quarter, a little higher than the 60 days' worth most analysts consider to be ideal, but not bad.
FCA's "LATAM" unit managed a profit, but just a small one -- 51 million euros, down from 169 million euros a year ago. The LATAM unit's shipments were down 14% in the quarter, in line with the overall industry's decline. As we saw at Ford and GM, an economic slump in Brazil and import restrictions in Argentina have clobbered new-vehicle sales in the region; but unlike Chrysler's old rivals, LATAM managed to turn a profit despite the difficult market.
There was some good news. New models helped FCA improve its net pricing, and market share in the region is up a bit over the year-ago period. Costs were up significantly, but a big chunk of the increase went to fund the start-up of FCA's massive new Jeep factory in Pernambuco, Brazil, under construction since 2012.
Asia-Pacific, Australia, China
FCA's "APAC" unit made 169 million euros, a big increase from 99 million euros in the year-ago period. Sales in the region were up 29%, with strong gains in China (33%), South Korea (28%), Australia (16%), and Japan (9%) more than offsetting an 18% decline in sales in India. APAC gained market share in all of its major markets save India, with a strong 0.7-point gain in Australia.
The big news for APAC was Jeep, which accounted for 52% of the unit's sales during the quarter. That's a 37% year-over-year increase attributable to strong sales of the big Grand Cherokee, and the new-to-the-region midsize Cherokee. APAC also sells the Dodge Journey in Australia, Indonesia, and a few other markets; Dodge-brand sales rose 21% in the region.
APAC's year-over-year profit gains were more than explained by improved sales volumes and richer product mix. Net pricing slipped a bit, in part due to competitive pressures in China, and partly due to adverse foreign-exchange effects on vehicles exported to Australia, CFO Richard Palmer said.
FCA's "EMEA" unit lost 63 million euros in the third quarter, an improvement over the 116 million euro loss it posted a year ago. Deep recessions in several key European nations sent new-vehicle sales to two-decade lows last year; the region has recovered somewhat, but the going is still rough for nearly all of the automakers that do business there.
EMEA is making progress, though. Sales of passenger cars were up 1%, though market share fell slightly as it discontinued some models in Italy. Commercial-vehicle sales rose 11%, with 0.3 points of market-share gain across the region.
Increases in sales volumes, a richer product mix, and some improvements in costs helped narrow EMEA's loss versus its year-ago results. That was partially offset by a decline in net pricing, as Europe's automakers continue to compete fiercely for a relatively small pool of ready buyers. The cost improvements came from "improved manufacturing and purchasing efficiencies," offset a bit by the start-up of a new assembly line at FCA's plant in Melfi, Italy. That new line began production of the small Jeep Renegade during the quarter.
Luxury brands: Ferrari and Maserati
FCA reports results for its luxury brands, Ferrari and Maserati, on a worldwide basis, separate from its regional results.
Ferrari earned 89 million euros during the quarter, up slightly from 88 million euros a year ago. Revenues of 662 million euros were up 24%, but profits were affected, in part, by 15 million euros in compensation costs related to the departure of longtime Ferrari chief Luca di Montezemolo.
Worldwide shipments were up 8% during the quarter; an 81% increase in Asia-Pacific more than offset a 14% decline in the U.S., Ferrari's No. 1 market. Ferrari's operating margin was 15.7% during the quarter -- still outstanding, but down from 16.5% a year ago.
Maserati earned 90 million euros on revenue of 652 million euros, a big jump from 43 million euros and 444 million euros a year ago. Sales rose 125% to 8,896 thanks to strong worldwide results for Maserati's new Quattroporte and Ghibli sedans. Maserati's operating margin was a strong 13.8%, up from 9.7% last year.
FCA's "components" group, which includes auto-industry suppliers Magneti Marelli, Teksid, and Comau, earned 48 million euros, up from 37 million euros a year ago. Revenues at Marelli, the biggest unit, rose 15% on higher sales volumes.
Debt, cash, and FCA's outlook
FCA reiterated its full-year guidance for 2014. It still expects total sales to come in around 4.7 million, and earnings before interest and taxes to be in the 3.6 billion euros to 4.0 billion euros range. Debt -- which rose to 11.4 billion euros during the quarter on seasonal effects -- is expected to be between 9.8 billion euros and 10.3 billion euros by year-end.
As of the end of the third quarter, FCA had a total of 21.7 billion euros in cash and credit lines available.
The upshot: FCA's plan is coming into clearer focus
Back in May, Marchionne and FCA's executive team announced an ambitious -- some might say audacious -- five-year plan for the company that calls for FCA's sales to increase to 6.3 million units by 2018, with pre-tax profits rising to around 9 billion euros, on a slew of new products -- including a complete relaunch of the storied Alfa Romeo brand.
The big question raised by that plan was, "How the heck will FCA pay for it?" The answer to that question is coming into clearer focus: The spinoff of Ferrari, together with the convertible debt issue, will help fortify FCA's balance sheet against any future global economic downturns. Meanwhile, increased revenues, driven largely by the global expansion of Jeep, will help fund the ambitious product-development efforts critical to FCA's profitability goals.
Will it work? If the products are strong, it just might -- but, at least in the U.S., FCA's offerings are at the bottom of the quality charts right now. Improvements on that front will be critical to the Italian-American automaker's future success.