The automotive sector crisis and two thoughts on Fiat spa

The automotive industry is in a very serious crisis. The US automobile market has been literally collapsing forcing the US Government to step in and save GM and Chrysler with a multi billion emergency loan. Ford is not in a much better situation, having burned more than 5 billion dollars in the 4Q 2008 alone. The Japanese automakers (Toyota, Honda, Nissan) which have a very important percentage of their sales in the US are also under pressure. Their situation is worsened by the strengthening of the yen against the dollar and the euro which is caused by the unwinding of the carry trade and the fall of interest rates in both US and Europe. Toyota has lost its AAA rating and has announced that it now expects an operating loss in 2009.
The European market has also experienced weakness in 4Q 2009 and major players now expect global sales to shrink by 20%-30% percent in 2009.

Right now I'm bearish on both equity and bonds of those issuers, but I'm following the sector because i think that some opportunities could arise as soon as late 2009 or in 2010 since many issuers could be downgraded by the rating agencies (we may even see some fallen angels, corporations which lose Investment Grade status and become High Yield issuers, with usually very negative consequences for their outstanding bonds) and the default of a big player in the industry could happen, putting considerable pressure on the price of automotive bonds.

Fiat spa (the main Italian automaker) released 4Q&FY 2008 results some days ago, i think that some figure are especially interesting to understand what's going on so let's give them a look (the pictures are taken from Fiat spa presentation for the analysts):


Let's take a look at Fiat cash flow in 2008 (click on the image to see the enlarged version). As you can see the company, despite it reported record trading profit in 2008, generated an operating cash flow of only 156 m euro. The reason is the adverse development in NWC (Net Working Capital = Inventory + accounts receivables - accounts payables), which absorbed 3,604 m euro of cash. We will return on this later.

Capital intensive business like this need very huge investments to continue to operate and to remain competitive, Fiat had a very heavy CAPEX (Capital Expenditures) in 2008: nearly 5 billion euro. The pathetic operating cash flow could do nothing to cover this absorption of cash and Fiat net industrial debt increased by a whopping 6,304 m euro.

This level of cash burning is obviously not sustainable, if things don't improve soon they could have difficulties in refinancing their debt and honoring their maturing obligations.
The problem is that what has happened in the US is now happening in the European market: auto sales are plunging. EU auto sale fell 27% in January 2009.
The EU market will shrink by roughly 20% in 2009 according to estimates, and it may non recover in 2010.
Fiat trading profit in 2008 could transform in a substantial loss in 2009, and the cash burning process will probably go on. Additional cash could be soaked up because of adverse developments in NWC (the more the net working capital increases the more it sucks up cash, the opposite is also true: the more it decreases the more it frees up cash).

Let's take a look at the development of Fiat's NWN in 2008:

Take a look at the increase in inventories as the revenue goes down. Like many other competitors Fiat is tryng to reduce inventories while sales are falling by temporary shutting down production in factories.
So we should expect inventories to fall, reducing NWC.
Trade receivables follow revenue, so we should expect them too to contract reducing NWC.
The problem is that trade payables are falling too due to the production stoppage.
The increase in NWC due to the fall in trade payables could more than offset the decrease in inventories and payables.
That's why i think that NWC could soak up cash again in 2009.

So you end up with a negative operating cash flow and you have to finance the CAPEX, which will be more conservative in 2009 than in 2008, but will still be there.

This means that debt will increase even further.

Lets take a look at the breakdown of Fiat net financial debt:

The net financial debt increased to 17,9 billion euros in 2008. Fiat draw 2 billion of committed lines in 4Q 2008, exhausting all it's remaining credit lines.

17,9 billion of debt becomes a problem when you are going to generate negative cash flow, especially if you have heavy short term maturities:


Fiat has 4,8 billion of total cash maturities in 2008 and 3,9 billion in cash & marketable securities. The only way it can repay them with a negative cash flow is by renegotiating them or contracting new debt.

Right now Fiat is negotiating a 3 billion credit line with some big Italian banks.

The next quarters will tell us if that's enough to cover it's financial needs.