This was an interesting quarter for Fiat Chrysler because they completed their spin off of Ferrari on the first day of the quarter.

We sold our shares in Ferrari shortly after the spinoff. There is a strong case to be made for Ferrari to grow earnings through increased volumes, pricing, licensing, and reduced R&D. There is also an argument that the company is a luxury goods company and should command a luxury multiple. I think they are both valid, but when I am honest with myself, I am not comfortable owning a luxury goods company at a luxury goods multiple. Recognizing this bias meant that if and when the multiple was ever tested, I would throw in the towel and sell on the weakness. The price decline would test my skepticism of the multiple and I would inevitably sell.

Given that Fiat itself is so inexpensive, I put additional funds into Fiat.

I think Sergio Marchionne has made the right move at just about every turn – from acknowledging that auto companies need to be better stewards of capital, to calling for industry consolidation, to emphasizing the higher margin Jeep products. In the first quarter, the company gained access to Chrysler’s cash, which had previously been “ring fenced,” creating a situation where the company was paying interest on more than 20 billion euros in debt while simultaneously having billions in Chrysler cash earning virtually nothing. When the ring-fenced cash is accessed, the debt significantly reduced. Just accessing the Chrysler cash will save the company several hundred million euros per year, which is meaningful for a company with adjusted EBIT of €4.8 billion in 2015. The company is nearing the end of a long investment cycle and is making significant operational improvements.

The shares are trading at less than 2X earnings management put forth in their 2018 plan. We are caught in a situation with short-term earnings improvement from all of management changes, which are very positive, but at the end of the day it remains a cyclical business with compressing multiples as investors fear the inevitable “end to the cycle” and begin to factor in those losses. Due to the capital intensity of the business, the cyclicality, our being closer to the end of the cycle than the beginning of the cycle, and a desire not to own the shares through the next recession – our time horizon is more limited on Fiat Chrysler than it is on most companies that we own.

Scott Miller is an instructor at Wide-Moat Investing Summit 2016.


This post has been excerpted from the Greenhaven Road Capital Q1 2016 Letter.

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