February 26, 2019 / 10:40 AM / 23 days ago

Breakingviews - Cruising Peugeot risks running out of gas

A man passes cars on a showroom forecourt in west London November 6, 2008. British new car registrations fell by an annual 23 percent in October, the steepest decline this year, the Society of Motor Manufacturers and Traders (SMMT) said on Thursday. REUTERS/Toby Melville

LONDON (Reuters Breakingviews) - Peugeot maker PSA Group has been the best of a bad bunch among European carmakers. The French group’s shares are up about 20 percent in the past year, compared with a 10 percent fall for Volkswagen and Fiat Chrysler’s 25 percent decline. Yet Chief Executive Carlos Tavares’ purring engine risks running out of gas.

The 20 billion euro company has been boosted by Tavares’ turnaround of Opel-Vauxhall, the previously loss-making business it bought from General Motors in 2017. That unit generated 859 million euros of operating profit in 2018, implying a 4.7 percent margin, compared with an operating loss equivalent to 2.5 percent of sales in the last five months of 2017.

The wider group’s 7.7 percent operating margin is comfortably ahead of French rival Renault’s 6.3 percent last year. And PSA’s 3.5 billion euros of free cash flow is greater than the amount generated by the core businesses of German peers Volkswagen, Daimler or BMW, according to Evercore ISI estimates.

The future might be less rosy. Tavares’ new medium-term goal of a 4.5 percent operating margin for PSA implies that profitability will decline significantly, as auto sales pass their cyclical peak and fixed costs eat up a greater chunk of revenue. Granted, the target could be overcautious. But PSA’s future growth is another worry. Almost all the company’s sales come from Europe – a slow-growing market with relatively stringent penalties for combustion-engine carbon emissions. Tavares wants to take Peugeot into North America, but that market is highly competitive and would increase the group’s sensitivity to possible tariffs from a lasting global trade war.

PSA is valued at almost six times 2019 earnings – nearly 20 percent above the average of Renault, Fiat Chrysler and Volkswagen, based on Refinitiv estimates. Investors seem to be giving the French group credit for a successful Opel-Vauxhall turnaround, and ignoring the risk that its growth and profitability could decline. Tavares’ premium valuation might not last.

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