Fiat Chrysler Earnings: Profits Are Too Thin for Comfort

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Despite strong pickup and SUV sales, FCA's profit margin in North America was extremely thin. The company said that it plans to fix that soon. Source: Fiat Chrysler Automobiles.

Fiat Chrysler Automobiles said on Wednesday that its first-quarter pre-tax profit rose 22%, thanks mostly to a big favorable shift in exchange rates.FCA's earnings before interest and taxes rose to 800 million euro from 655 million euro in the year-ago quarter. Its net income of 92 million euro -- about $101 million -- was a big improvement over the $190 million loss it posted a year ago.

But 130 million euro of that EBIT improvement was due to favorable exchange-rate shifts, CFO Richard Palmer said. Compared to its healthy Detroit rivals, FCA's underlying business still has some big issues.

Improvement in Europe, but profits remain thin
First, a word about that exchange-rate boon. First-quarter results at rivals Ford and General Motors were both dented by exchange-rate shifts. The U.S. dollar has strengthened against most foreign currencies recently. For Ford and GM, that means that profits earned overseas buy fewer dollars than they did a few months ago.

But for post-merger Fiat Chrysler, it's a boon. That's because FCA is technically a Dutch company, so it reports its results in euros. The dollars that it earns in the U.S. buy more euros now than they did before. Hence the gain.

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FCA did have some good news to report beyond an exchange-rate windfall. Its European unit reported a profit for the second quarter in a row, albeit a modest one (25 million euros). Still, that's better than the big losses that both Ford and GM continue to report.

Meanwhile, in North America, FCA earned 601 million euros before taxes, as strong sales of profitable Ram pickups and Jeep SUVs -- and some help from exchange rates -- helped drive a 58% year-over-year profit gain.

U.S. sales of the overhauled-for-2015 Dodge Challenger rose 45% in the first quarter. Source: Fiat Chrysler Automobiles.

But for all the pickups and Jeeps it's selling in the U.S., FCA isn't making as much money as it should be. Its operating profit margin of 3.7% lags far behind what Ford (6.7%) and GM (8.8%) reported in the first quarter -- and Ford's is expected to rise sharply as the year goes on.

Given that U.S. auto sales are probably not going to grow a whole lot from here, that margin needs urgent attention before the next downturn. FCA chose to address that challenge head-on in its earnings call on Wednesday.

How FCA will boost profits in North America
After walking through the usual earnings report, Palmer gave a second presentation to investors on the earnings call, revealing the company's plan for closing the gap in profit margin to Ford and GM by 2018. As he sees it, there are two areas where FCA has to take action. One is its own production costs, and that will involve the same kinds of things Ford and GM have made progress on: Consolidating platforms, improving relations with suppliers, and so forth.

But FCA also has an opportunity to improve margins by changing the mix of vehicles it sells and to whom, Palmer said. He presented several slides showing how FCA's mix of offerings compared with Ford's and GM's, and it was instructive.

For instance, FCA's Ram pickups are priced comparably to Ford's F-Series and GM's Chevy Silverado, but Ford and GM get better average transaction prices. Why? Because on average, Ford and GM pickups go out the door with more options, or in industry speak, a "richer mix."

That's why FCA recently rolled out new higher-end Ram models. But there's more to be done. FCA's spending on "incentives" -- those cash-back or cheap-financing deals we see in ads, has long been among the industry's highest. That's changing, Palmer says, starting this month.

It will take more time to change things like FCA's mix of fleet sales. Compared to Ford and GM, FCA makes fewer fleet sales as a percentage of its overall sales. That's good, as fleet sales tend to generate lower profits per sale than retail sales. But Ford and GM make more sales to commercial fleets -- which are more lucrative -- and fewer to rental-car fleets -- which generate very thin profits -- than FCA. Changing that mix is another opportunity for FCA.

Work on all of these fronts is underway, Palmer says, and the results should start to be visible soon. He expects FCA's margin in North America to rise substantially this year, from 4.1% in 2014 to between 5.5% and 6% for the full year, with the fourth quarter's result coming in around 7%. By 2018, he expects FCA"s North America margin to be comparable to Ford's and GM's, around 9%.

Cash, debt, and outlook
FCA's cash position isn't bad. It had 21.9 billion euros in cash as of the end of the quarter, and another 3.3 billion euros in available credit lines, for total liquidity of 25.2 billion euros. Debt is up a bit to about 8.6 billion euros, a result of FCA's big capital expenditures -- or put another way, the huge investments FCA is making in a slew of new products.

FCA is investing big in a slew of new products, including a whole new line of Alfa Romeo models. Source: Fiat Chrysler Automobiles.

CEO Sergio Marchionne strongly reaffirmed that FCA is on track to meet the objectives it outlined in its five-year plan announced last year. He and Palmer also reaffirmed FCA's previous guidance for 2015: pre-tax earnings of 4.1 billion euros to 4.5 billion euros, net profit of 1.0 billion to 1.2 billion euros.

Long story short: Compared to Chrysler's traditional Detroit rivals and other big automakers, FCA still has a lot of work to do. Its profits are just too thin, particularly in North America, where the market has been extremely favorable for its most profitable products.

But Marchionne and his team seem well aware of the challenges facing FCA, and are determined to address them. If they can lift FCA's profitability in North America during the next few quarters, a lot of the company's other issues might get easier to fix. We'll see.

The article Fiat Chrysler Earnings: Profits Are Too Thin for Comfort originally appeared on Fool.com.

John Rosevear owns shares of Ford and General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.