That’s amore: Fiat fuelled by Chrysler love

The full takeover of Chrysler makes complete sense for Fiat given how reliant the Italian carmaker is on Chrysler's profits. Unfortunately it means more capacity for an industry already suffering from oversupply.

For global carmakers, this week’s announcement that Italy’s Fiat group will acquire the 41.5 per cent of Chrysler that it didn’t already own, while not unexpected, isn’t a positive development. It also helps add some perspective to the gradual demise of the Australian car manufacturing sector.

When the Productivity Commission produced its preliminary report on the local automotive industry last month it made the point that global production capacity exceeds demand, creating pressure for plant closures and rationalisation within the developed countries where the imbalances are greatest.

It noted that the global benchmark for capacity utilisation is that carmakers need to operate at more than 80 per cent capacity to be profitable. The US (barely), Germany, Japan and Mexico are the only countries that meet the benchmark.

The country with the most over-capacity was Italy, where production in 2012 represented less than 40 per cent of the sector’s auto manufacturing capacity.

In 2012, if its shareholding in Chrysler were excluded, Fiat lost about $1.6 billion. In the nine months to September 2013 Fiat ex-Chrysler lost about $1.1 billion.

With nearly $16 billion in net debt, Fiat would be in terrible strife if it weren’t for the interest in Chrysler that it has been building since 2009. Chrysler’s profitability turned the $1.1 billion loss in the nine months into a $1 billion profit.

Without Chrysler, Fiat either wouldn’t have survived or would have been forced to make some drastic cuts to its capacity. Instead the two groups have been gradually integrating their operations, with Fiat producing small car platforms for Chrysler and Chrysler focusing on larger cars, SUVs and four-wheel-drives.

There has been a steady shift within the industry over recent decades towards global platforms, which has been one of the key issues confronting the Australian carmakers. The acquisition of 100 per cent of Chrysler will facilitate that process within Fiat.

Fiat does make money in Brazil, although profitability there is slowing in line with the economy and amid intensifying competition, as well as in Asia Pacific. The tie-up with Chrysler, however, has helped it to avoid the radical restructure of its core European operations – it has 44 plants in Italy and 33 elsewhere in Europe – that its financial condition would otherwise have forced on it.

Full ownership of Chrysler will enable even closer integration, as well as complete access to Chrysler’s profits and the more than $15 billion of cash within the American business.

Chrysler has net debt of only about $1.6 billion, although Chrysler will finance about $2 billion of the $4 billion or so of its own acquisition price through a special distribution to its shareholders, so the overall Fiat group net debt of about $17.5 billion will be enlarged by the transaction.

Fiat will become a global player as a result of the deal, with the combined group ranking about seventh in the world in terms of production. The four million or so cars a year that the two companies produce, however, is less than half the nine million-plus produced by rivals like Volkswagen, Toyota and General Motors.

With the extra scale, and Chrysler’s balance sheet, Fiat plans a flood of new vehicles, and an investment of up to about $14 billion in its badly under-utilised Italian plants. The deal isn’t going to do anything to address the industry’s over-capacity, indeed it may exacerbate it.

In the face of the global production imbalances and the sub-economic decision-making typified by the Italian industry operating at less than half the levels required for profitability, it isn’t a surprise that Australia’s tiny and high-cost domestic car manufacturing sector is winding down. The only surprise is that it has survived (albeit with considerable taxpayer assistance) as long as it has.