European Autos & Parts 2009 Q4 Barclays

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware thatthe firm may have a conflict of interest that could affect the objectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified asresearch analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 177.

EQUITY RESEARCH 8 December 2009

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EUROPEAN AUTOS & AUTO PARTS:INITIATION OF COVERAGE PREPARE FOR POST-SCRAPPAGE PRICE WARS

ler0643 autos initiation cover_dec 09.qxp 07/12/2009 20:38 Page 1

Barclays Capital | European Autos & Auto Parts

8 December 2009

EUROPEAN AUTOS & AUTO PARTS – PREPARE FOR POST SCRAPPAGE PRICE WARS

We see 2010 as a year of unintended consequences from the scrappage programmes of 2009 for the European Auto sector, and expect volumes to fall, excess capacity to be exposed and pricing to deteriorate. As a result we favour stocks that have unrecognized cost reduction potential. We are initiating coverage with three key 1-Overweight ideas: Renault, BMW and VW Prefs and two key 3-Underweights: Fiat and Daimler.

Sector wise, we believe the sector is moderately expensive for what we see as a tougher than expected 2010 but reasonable in light of longer-term valuations. We are initiating with a 2-Neutral sector view and believe the time is right to refocus on stock selection.

Specifically we believe that:

The sector is no longer a near-term macro call with early cyclical recovery gains behind us;

2010 will be the year of unintended consequences from scrappage programme payback that will pressure not just on volumes but on pricing as the European consumer base becomes addicted to incentives; and

Given the toughening environment, we prefer players who can exploit already established scale positions by driving further cost savings via further commonality and modularity over those still scrambling to establish scale.

In terms of 1-Overweight, we are non-consensus on Renault. Among our 3-Underweight ratings, we are non-consensus on Daimler and Fiat.

Stock selection: Prefer players who can extract cost savings from established scale

Auto stocks have already priced in an economic bottom, with OEMs stocks outperforming YTD by 41% (on a raw basis vs. DJ STOXX, excluding VW ords). While investors are cautious toward sales declines in 2010, we believe they do not yet appreciate the degree to which pricing will be under pressure. This makes cost savings critical. To identify cost cutting potential, we believe investors should pay equal attention to the firm’s ability to increase modularity and commonality to exploit the scale – as well as the workforce flexibility to bring the productivity savings to the bottom line.

1-Overweights – We believe the market is underestimating Renault’s potential to take the Nissan alliance to the next level; BMW, where modularity and workforce demographics likely set up further cost reduction; and VW prefs are cheap even assuming dilution and merger risks.

2-Equal Weight – PSA as market appreciates product cadence and is already pricing in gains from a Mitsubishi alliance that will take years to extract; Porsche is primarily a vehicle to gather VW shares but with greater merger and dilution risk than the VW prefs.

3-Underweight – Daimler as workforce demographics inhibit further cost cutting; Fiat as the market overestimates Chrysler potential.

Sector view: 2-Neutral

We are initiating with a 2-Neutral view on the auto sector for three reasons: 1) At 27% EV/sales for 2010E, the sector valuation is in line relative to history (29%) and investors’ confidence in the sector may be shaken as pricing and volume deteriorates and scrappage programmes expire in early 2010, 2) But at 23% for 2011E EV/sales, the sector still offers upside for longer-term holders and 3) our analysis shows it is time to buy stocks based on company specifics, which points to in-line performance after this year’s rally.

European Autos & Auto Parts Brian A. Johnson 1.212.526.5627

[email protected] BCI, New York

Kristina Church

+44 (0)20 313 42199 [email protected]

Barclays Capital, London

1

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8 December 2009

Summary of our Rating, Price Target and Earnings in this Report

Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)

Old New 04-Dec-09 Old New %Chg Old New %Chg Old New %Chg

European Autos & Auto Parts N/A 2-Neu

BMW (BMW GY / BMWG.DE) N/A 1-OW 32.75 N/A 41.00 - N/A 0.24 - N/A 1.64 -

Daimler AG (DAI GY / DAIGn.DE) N/A 3-UW 35.91 N/A 32.00 - N/A -2.02 - N/A 0.61 -

Fiat SpA (F IM / FIA.MI) N/A 3-UW 10.56 N/A 8.00 - N/A 0.03 - N/A 0.05 -

Peugeot SA (UG FP / PEUP.PA) N/A 2-EW 24.18 N/A 26.00 - N/A -6.28 - N/A -1.90 -

Porsche Automobil Holding SE (PAH3 GY / PSHG_p.DE) N/A 2-EW 47.51 N/A 55.00 - N/A -14.29 - N/A 1.47 -

Renault SA (RNO FP / RENA.PA) N/A 1-OW 35.59 N/A 42.00 - N/A -10.30 - N/A 0.53 -

Volkswagen AG (VOW GY / VOWG.DE) N/A 2-EW 80.39 N/A 100.00 - N/A 4.18 - N/A 5.31 -

Volkswagen AG-PFD Preferred (VOW3 GY / VOWG_p.DE) N/A 1-OW 63.50 N/A 85.00 - N/A 4.17 5.29 -

Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.

FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.

Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating Suspended

Sector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative

2


8 December 2009 3

CONTENTS

EUROPEAN AUTOS – PREPARE FOR POST SCRAPPAGE PRICE WARS 1

THE YEAR OF UNINTENDED CONSEQUENCES 5

SCRAPPAGE HANGOVER LIKELY WORSE THAN CONSENSUS EXPECTATIONS 9

EU PRODUCTION TO WEAKEN SEQUENTIALLY BUT GLOBAL GROWTH PICKS UP 15

DESPITE LONG-TERM DOWNSIZING, MID-TERM GROWTH IS IN VOLUME C AND ABOVE SEGMENTS AS SCRAPPAGE DISTORTION FADES 17

SCRAPPAGE AND LOAN PROGRAMMES PRESERVED EXCESS CAPACITY 19

SCRAPPAGE SCHEMES MAY HAVE HOOKED EUROPEAN CONSUMER ON INCENTIVES SETTING UP PRICING PRESSURE 23

CURRENCY SHIFTS PRESSURE US AND UK IMPORTS 29

WE FAVOUR THOSE WITH DOMINANT HOME MARKET C & D POSITIONS 30

SCALE AND COMMONALITY PROVIDES BUFFER AGAINST UNINTENDED CONSEQUENCES 33

SECTOR VALUATION – 2-NEUTRAL 37

BMW – POTENTIAL FOR FURTHER COST CUTS DRIVES 1-OVERWEIGHT RATING 42

DAIMLER – MARKET OVER OPTIMISTIC ON COST-CUTTING POTENTIAL 59

FIAT – EXCESS CAPACITY AND LOWER CHRYSLER TURNAROUND ENTHUSIASM DRIVE 3-UNDERWEIGHT RATING 78

PEUGEOT – STRONG MODEL CYCLE, BUT UNDERWHELMED BY “NEW” STRATEGY – 2-EQUAL WEIGHT RATING 101

PORSCHE – MERGER BENEFITS MAY NOT FLOW TO PREF HOLDERS –: 2-EQUAL WEIGHT 121

RENAULT – POTENTIAL FOR GREATER COMMONALITY DRIVES 1-OVERWEIGHT RATING 132

VOLKSWAGEN – SCALE TO WITHSTAND PRICE WARS 152

For Valuation Methodology and Risk section, please see page 174


8 December 2009 4

Current Price Upside/ EPS EPS growth Sales Sales growth

Rating price Mkt Cap target downside 2009 2010 2011 2009 2010 2011 2009 2010 2011 2009 2010 2011

European OEMs

BMW AG 1-Overweight € 32.75 € 21,395 € 41.00 25% €0.24 €1.64 €3.14 -53% 586% 92% €41,341 €42,316 €45,215 -15% 2% 7%

Daimler AG 3-Underweight € 35.91 € 36,765 € 32.00 -11% (€2.02) €0.61 €2.20 -244% NA 259% €65,785 €69,512 €76,660 -24% 6% 10%

Fiat SpA 3- Underweight € 10.56 € 13,061 € 8.00 -24% €0.18 €0.05 €0.42 -88% -71% 723% €48,398 €44,852 €46,602 -17% -7% 4%

Peugeot SA 2-Equal Weight € 24.18 € 5,486 € 26.00 8% (€6.28) (€1.90) €2.87 NA NA NA €45,393 €45,923 €49,115 -14% 1% 7%

Porsche 2-Equal Weight € 47.51 € 8,314 € 55.00 16% (€14.29) €1.47 €4.74 -140% NA 222% €6,260 €7,094 €8,362 -16% 13% 18%

Renault SA 1-Overweight € 35.59 € 9,132 € 42.00 18% (€10.30) €0.53 €4.77 -563% NA 799% €30,230 €30,831 €33,089 -15% 2% 7%

Volkswagen (Ords) 2-Equal Weight € 80.39 € 32,169 € 100.00 24% €4.18 €5.30 €8.67 -65% 27% 63% €94,485 €94,299 €104,402 -8% 0% 11%

Volkswagen (Prefs) 1-Overweight € 63.50 € 25,410 € 85.00 34% €4.18 €5.30 €8.67 -65% 27% 63% €94,485 €94,299 €104,402 -8% 0% 11%

Mean -174% 142% 317% -15% 2% 9%

Median -88% 27% 222% -15% 2% 9%

US OEMs

Ford Motor Co. 2-Equal Weight $8.94 $31,268 $9.00 1% ($0.38) $0.60 $1.50 NA NA 148% $103,508 $116,441 $133,130 -15% 12% 14%

Rating Current 52 week Share price performance P/E EV/sales EV/EBITDA

price High Low Dec 08 1 month 3 month YTD 2009 2010 2011 2009 2010 2011 2009 2010 2011

European OEMs

BMW AG 1-Overweight € 32.75 € 36.48 € 17.22 € 21.61 0% 4% 52% 137.1x 20.0x 10.4x 20% 18% 18% 2.2 x 1.5 x 1.1 x

Daimler AG 3-Underweight € 35.91 € 37.90 € 17.20 € 26.70 10% 7% 34% NA 58.6x 16.3x 45% 44% 40% 11.7 x 5.4 x 3.7 x

Fiat SpA 3- Underweight € 10.56 € 11.47 € 3.32 € 4.59 -2% 28% 130% 59.7x 209.5x 25.4x 34% 35% 32% 4.5 x 4.9 x 4.1 x

Peugeot SA 2-Equal Weight € 24.18 € 25.67 € 11.30 € 12.15 4% 14% 99% NA NA 8.4x 6% 7% 7% 1.1 x 1.1 x 0.9 x

Porsche 2-Equal Weight € 47.51 € 61.20 € 27.12 € 54.85 -11% 6% -13% NA 32.3x 10.0x 187% 40% 27% 9.2 x 1.9 x 1.3 x

Renault SA 1-Overweight € 35.59 € 37.37 € 10.17 € 18.55 11% 8% 92% NA 67.0x 7.5x 11% 11% 13% 1.7 x 1.2 x 1.1 x

Volkswagen (Ords) 2-Equal Weight € 80.39 € 313.00 € 78.10 € 250.00 -25% -68% -68% 19.2x 15.2x 9.3x 67% 27% 20% 6.6 x 2.2 x 1.7 x

Volkswagen (Prefs) 1-Overweight € 63.50 € 82.90 € 29.55 € 38.02 -7% 9% 67% 15.2x 12.0x 7.3x 67% 27% 20% 6.6 x 2.2 x 1.7 x

Mean -2% 1% 49% 57.8x 59.2x 11.8x 55% 26% 22% 5.4x 2.6x 1.9x

Median -1% 8% 59% 39.5x 32.3x 9.6x 39% 27% 20% 5.5x 2.1x 1.5x

US OEMs

Ford Motor Co. 2-Equal Weight $8.94 $9.14 $1.50 $2.29 20.0% 11.6% 290.4% NA 14.8x 6.0x 54% 48% 38% 16.1 x 7.3 x 4.3 x


8 December 2009 5

THE YEAR OF UNINTENDED CONSEQUENCES

Governments in Europe and the US intervened on an unprecedented scale in automotive marketplaces in 2009. Various forms of scrappage programmes boosted sales by 3mn units in Europe and 700,000 units in the US. Government financial support to automakers included loans in France and Germany (Opel), and bailouts of Chrysler and GM in the US. But we see 2010 as a year of unintended consequences when volume falls, excess capacity is re-exposed and pricing deteriorates. As a result, we favour stocks that have unrecognised cost reduction potential.

The positive, intended consequences of government interventions accounted for much of the rally in European autos since their lows of January 2009. With the prominence of automobile sector to European employment (2.2mn jobs in 2007, or 7% of manufacturing employment in the EU27), governments stepped in to cushion the fall. Germany, with over 800,000 jobs at stake, took the lead, followed by other major manufacturing countries.

As a result, sales in pan-Europe (ex-Russia and Turkey) are likely to have fallen by only 5% from 2008 to 2009, note that sales would have fallen by 20% without scrappage programmes. After a dip in 1Q09 production to 3.4mn units, production in the remainder of 2009 will have averaged 4.3mn units a quarter. This led to a “positive, albeit small” contribution to 1H09 GDP at a cost of less than 0.1% of GDP in the euro area (see European Central Bank, Monthly Bulletin, October 2009). In the US, the Chrysler and GM bailouts preserved up to 600,000 jobs at GM and Chrysler and their suppliers, and prevented significant disruption in the supply chain and cascading supplier bankruptcies.

However, 2010 and beyond will see the negative unintended consequences of the government interventions play out in Europe -- only some of which we believe are fully understood by investors:

First, sales in Western Europe are likely to fall 13.6% (that is, we believe 400bp worse than consensus) as scrappage programmes expire and underlying demand remains anaemic.

Second, excess capacity and globally uncompetitive labour rates will persist.

Third, and perhaps least well understood, the scrappage programmes likely hooked the European consumer on incentives, leading to very weak pricing over the next several years all the way up to the luxury segment -- in stark contrast to the strong pricing that otherwise concentrated local markets have allowed.

Fourth, in another sector of government intervention, the two governments which have been most aggressive in propping up their banks and expanding their national debt -- the US and UK -- have and are likely to continue to suffer from weak currencies that hurt exporters into those geographies.

So what are investors to do? First, we are cautious on the overall sector. We expect 2010 to be weaker for the industry than most believe, although at current market prices we still see value out to 2011 and beyond as demand recovers allowing capacity utilisation and pricing to improve. Second, we believe pricing and currency pressures are most acute in the luxury segment, we do not favour luxury over volume. Finally, given the pressures, we are looking to companies that have superior resilience (at least relative to market expectations) to the weak pricing, currency and demand environment due to their market and cost positions.

Effects of government interventions & scrappage

schemes likely to linger

W Europe sales to fall near 14% in 2010E, 400bp worse than

consensus forecasts

We are cautious on the sector as a whole – 2010-11E likely

weaker than market anticipates

Excess capacity, pricing & currency pressures to weigh on

sector – most acutely on luxury manufacturers


8 December 2009 6

BMW (1 – Overweight, €41 price target) (see page 42)

We are initiating coverage of BMW with a 1-Overweight rating and €41 price target, based on a combination of EV/sales and PE metrics and historical and peer averages. Given the pricing, demand, and currency pressures we expect to continue in the premium market, we favour companies that can deliver and retain near and mid-term cost reductions ahead of market expectations. BMW is a well-understood story as regards its upcoming model launches; nevertheless, we believe the market is underestimating the company’s potential for deeper and further cost savings via Strategy #1, both as a result of the full roll-out of its modular strategy and as a consequence of increased flexibility regarding employee costs due to an ageing workforce and extensive use of temporary workers. Moreover, while not part of Strategy #1, BMW’s more extensive manufacturing presence in the UK and US provides more of a natural currency hedge offsetting the strength of the euro.

Daimler (3- Underweight, €32 price target) (see page 59)

We are initiating coverage of Daimler with a 3-Underweight rating and €32 price target due to our expectations that the market has run ahead of itself on its forecasts for Daimler’s cost saving potential. We expect pricing, demand, and currency pressures to continue in the premium market and therefore favour companies that can deliver and retain near and mid-term cost reductions ahead of market expectations. Although management have committed to an additional €4bn cost savings for 2010E, we are concerned that the majority of these will be absorbed be negative factors (price, FX and raw material costs), whereas we believe market assumptions are overestimating the retention potential. We believe that DAI is also more exposed to pricing risks than BMW, having unfortunately launched its E-class into a falling luxury market and with less natural hedging is more exposed to FX risks than its peer. We also think that with Mercedes’ youthful workforce, its lack of modular-focused savings (relative to BMW and especially Audi/Porsche), and its belated efforts in the field of fuel economy provide less fat to trim. Even using consensus estimates for the truck sector (which we believe is risky given that the market seems to be underestimating the tepid recovery potential for the European truck market) our forecasts still remain 40% below market expectations for 2010E. Valuation metrics further point us to prefer BMW (currently 18% 10E EV/sales vs 44% at DAI, though admittedly DAI also incorporates high-rated trucks) and lead us to initiate coverage of Daimler with a 3-Underweight rating and a €32 price target.

Fiat (3- Underweight, €8 price target) (see page 78)

We are initiating coverage of Fiat with a 3-Underweight rating and a €8 price target. While Fiat has rallied recently on hopes for Chrysler and press speculation of an FGA spin-out, we believe that while Chrysler is likely to survive through 2011, even a strong turnaround (albeit below management projections) would be worth only €1.50 per Fiat share by 2012. Moreover, by Fiat’s own admission, the prospects for a spin-out of Fiat Group Automotive, which would in our view unlock the value of CNH and Iveco, are remote in 2010. As a result, we believe investors will refocus on the core automotive business, which faces a difficult year as scrappage programmes fade away across Europe. As the programmes fade, we think Fiat, which benefited significantly from the shift to A and B vehicle segments, will be hit hard as volumes fall and price competition sharpens. The fall in volume will once again reveal the excess capacity in Italy, leading to negative headlines and difficult negotiations as Fiat navigates the delicate task of closing Italian capacity. We are therefore initiating coverage of Fiat with a 3-Underweight rating and we value the Fiat share based on an average of EV/sales and EV/EBTIDA at historical and peer average multiples, which lead us to our €8 price target.

BMWG.DE / BMW GY

Stock Rating 1-OVERWEIGHT

Sector View 2-NEUTRAL

Price Target €41.00

Price (04-Dec-2009) €32.75

Potential Upside 25%

DAIGn.DE / DAI GY

Stock Rating 3-UNDERWEIGHT



Price (04-Dec-2009) €35.91

Potential Downside 11%

FIA.MI / F IM



Price Target €8

Price (4-Dec-2009) €10.56



8 December 2009 7

Peugeot (2- Equal Weight, €26 price target) (see page 101)

Our 2-Equal Weight rating on Peugeot is based on our concern regarding the company’s lack of scale both geographically and on a platform-by-platform basis. We believe that the market is already well versed in Peugeot’s strong upcoming model line-up and is already over-crediting the company’s revenue growth potential in 2010 and beyond. We also believe that of the targeted €3.3bn of gross cost savings, the company is only likely to retain €2.1bn. Though Peugeot’s superior product mix and the upside potential if a buyer were to be found for its Faurecia stake prevent us from taking an underweight stance, likewise, the company’s lack of scale and the market’s over-confidence in its future cost saving potential steer us away from an Overweight rating. As with Renault, we base our valuation on a SotP methodology, which we confirm against peer average EV/EBITDA multiples in order to reach our price target of €26. We are initiating coverage of Peugeot with a 2-Equal Weight rating.

For equity investors who are looking for exposure (delta) to the underlying equity, but with the defensive characteristics of downside protection, senior status, an income advantage and strong takeover and dividend protection features our Barclays Capital convertibles analysts recommend Peugeot’s 2016 convertible.

Porsche (2- Equal Weight, €55 price target) (see page 121)

We are initiating coverage of Porsche with a 2-Equal Weight rating and a €55 price target reflecting the uncertainties and risks in the next 16-18 months. While Porsche’s near-term prospects as a sports car manufacturer are strong in the face of a challenging market, the real value of Porsche’s pref shares lie in the current 51% holding of VW shares and their eventual conversion into VW NewCo shares (likely prefs). While we maintain a positive stance toward VW prefs (with a 1-Overweight and €85 target), we believe that public shareholders in both firms face transactional risk around the future fundraising and eventual merger ratios. With VW we believe that the ultimate earnings power, against the near-term low valuation in light of Qatari share sales, offers better protection against the vagaries of offering dilution and exchange ratios than do the Porsche prefs. We base our price target for the Porsche’s preference shares using an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples leading us to our €55 price target.

Renault (1- Overweight, €42 price target) (see page 132)

Our 1-Overweight rating on Renault is based on the thesis that the ‘glass is half full’ in relation to future potential synergies from the Nissan alliance. Whilst we acknowledge that the company is currently in a far from secure position in balance sheet terms and is yet to show evidence of current profitability in its automotive business, we believe that this leaves plenty of upside to the current share price when recovery sets in. In the near term, Nissan’s exposure to the US and emerging markets will likely aid Renault’s earnings but where we feel that real additional value can be extracted from the Renault share is via the longer-term potential for increased use of commonality on platforms shared with its Asian associate. The unlocking of such synergies has long caused heated debate among analysts but we believe that RNO management are now whole-heartedly focused on both near-term cash management but also on turning their association with Nissan into something more obviously tangible. We are optimistic that 2010E will herald the beginning of an improved cash management strategy, which will include the sale of selected property assets and of any non-strategic investments, such as the Volvo stake. As at Peugeot, we base our valuation on a SotP methodology, which we check against peer average EV/EBITDA multiples to reach a price target of €42, which in turn drives our 1-Overweight rating.

PEUP.PA / UG FP

Stock Rating 2-EQUAL WEIGHT



Price (04-Dec-2009) €24.18

Potential Upside 8%

PSHG_p.DE / PAH3 GY




Price (04-Dec-2009) €47.51


RENA.PA / RNO FP




Price (04-Dec-2009) €35.59



8 December 2009 8

Volkswagen Prefs (1- Overweight, price target €85) and Volkswagen Ords (2- Equal Weight, price target €100) (see page 152) We are initiating coverage of Volkswagen with a 1-Overweight rating for the pref shares and a €85 price target, and with a 2-Equal Weight and €100 price target for the ordinary shares. We believe that VW is the most advanced of the European auto makers in capturing economies of scale – and is likely the world benchmark for modularity – which should give it the cost position to withstand the intense price competition we expect in 2010. Moreover, we do not view the potential Porsche merger and attendant financial manoeuvring as posing significant downside risk to VW pref holders, as VW appears to have protected itself against an inordinate amount of net debt on Porsche’s balance sheet. Any potential ‘overpayment’ for Porsche assets is only at most in the range of €6-7 per VW pref share – small in light of the significant upside potential as VW returns to 4% EBIT margins by 2012 (which would be below our longer term projections of 6-7% in 2014-15). We value the VW shares based on an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples, which lead us to our €85 price target for prefs and €100 for ords.

At the same time, we recognize that VW is seen as a consensus overweight – yet has been a stock that has repeatedly punished the consensus trade. Given the erratic movements of Volkswagen’s shares many investors are loath to enter into a position that could result in substantial losses. These investors should, in our view, consider options as an alternative to the shares, with the benefit that the maximum loss to a long call or put position is the premium paid.

VOWG.DE / VOW GY VOWG_p.DE / VOW3 GY

Stock Rating 1-OW prefs / 2-EW ords


Price Target €85.00 prefs / €100.00 ords

Price (04-Dec-2009) €63.50 prefs / €80.39 ords

Potential Upside 34% prefs / 24% ords


8 December 2009 9

SCRAPPAGE HANGOVER LIKELY WORSE THAN CONSENSUS EXPECTATIONS

Consensus expectations for European sales in 2010E appear to be for a slight softening in the range of 8-10%. We believe that government interventions clearly distorted the European market in 2009, masking what would have been a steep 25% decline in total Europe, had scrappage schemes not been initiated. This will be a difficult hole to climb out of given limited spillover of scrappage programmes into 2010, likely effects of pull ahead of 2010E sales into 2009, and expected weak euro area macroeconomic growth.

2009 W European sales would have declined 19% to 11mn units without government interventions

The European auto downturn of 2008-09 came after nearly a decade of sales that fluctuated mildly in Western Europe (between 14.2mn units and 15.1mn) while growing healthily in Eastern Europe to 1.2mn in 2008. For the full year 2009, we expect sales to reach 13.1mn in Western Europe, 870,000 in Eastern Europe and 1.9m in Russia, Turkey and former Soviet Union states – for a net decline of -3.4% in W Europe and -14% in total Europe (or a cumulative decline since 2007 of -12% and -18% respectively).

However, nearly 3mn of the 13.1mn sales in W EU in 2009E are likely to have been subsidized by scrappage programmes, which were adopted to varying degrees by the five major Western European markets as well as well as five of the smaller WE states and two of the new EU members.

Figure 1: European car registrations historical and forecast, 2007A-2012E (units in 000’s)

Registrations (units in 000’s) YoY Chg (%)

2007 2008 2009E 2010E* 2011E 2012E 2009E 2010E 2011E

Germany 3,147 3,090 3,750 2,543 2,892 3,228 +21.4% -32.2% +13.7%

UK 2,404 2,132 1,860 1,773 1,882 1,904 -12.7% -4.7% +6.1%

Italy 2,493 2,162 2,000 1,746 1,932 2,384 -7.5% -12.7% +10.7%

France 2,065 2,050 2,150 1,934 2,109 2,071 +4.9% -10.0% +9.0%

Spain 1,615 1,161 880 744 807 1,087 -24.2% -15.4% +8.4%

Rest of W Europe 3,075 2,966 2,460 2,579 2,725 2,876 -17.1% +4.8% +5.7%

Total W Europe 14,798 13,561 13,100 11,320 12,347 13,550 -3.4% -13.6% +9.1%

New EU States 1,162 1,179 870 932 978 1,117 -26.2% +7.1% +5.0%

Pan-EU 15,960 14,740 14,000 12,252 13,300 14,700 -5.0% -12.5% +8.6%

Russia 2,364 2,708 1,312 1,462 1,708 2,000 -51.6% +11.4% +16.9%

Turkey & FSU Countries 1,054 1,101 622 670 820 938 -43.5% +7.8% +22.2%

Total Europe 19,377 18,549 15,934 14,385 15,828 17,638 -14.1% -9.7% +10.0%

Note: * assumes low level of extension to scrappage schemes in Italy, France, UK & Spain. Source: ACEA, JD Powers, Barclays Capital

W European sales to fall only -3.4% (-14% total Europe) in

2009E but masking a -19% drop (-25% total Europe) had

scrappage schemes not proliferated.


8 December 2009 10

Figure 2: European summary of current scrappage schemes

Campaigns underway Discussions

UK: £2000> 10 years£400mn10 months 2009-10

F: €1000 + staggered tax staggered tax rebate up to €5000> 10 yearsNew car max 160 gCO2/km (staggered) €220mn1 year 2008 – 2009Proposal for extension 2010

NL: €750–1,000 cars€750–1,750 LCVs> 13 years (petrol)> 9 years (diesel) €65mn2009-10

P: €1000/1250> 8 years, > 13 years, New car max 140 gCO2/km5 months 2009

L: €1500/1750> 10 yearsNew car max 150 gCO2/km1 months 2009

E: Plan 2000E: €2000Plan VIVE: interest free loan (€10,000 max)> 10 years, or 250,000 km car max 5 years, max 140gCO2/km1.5 years 2008–2010

I: €1500 – 3000 cars€2500 – 6500 LCVs> 9 yearsNew car max 130-140gCO2/km11 months 2009

GR: new scheme announced:€1500 – 3200 cars€2000 – 3700 LCVs€7000 – 13000 HDVs2009 – 2012

SK: €2000 > 10 years€22.1 mn9 months 2009

RO: €1000 > 10 yearsMax 60,000 vehicles11 months 2009

A: €1500 > 13 yearsNew car min Euro 4€45 mn9 months 2009

D: €2500 further tax rebate for Euro 5/6 cars > 9 yearsMin Euro 4, max 1 year €5 bn1 year 2009

Campaigns underway Discussions

UK: £2000> 10 years£400mn10 months 2009-10

F: €1000 + staggered tax staggered tax rebate up to €5000> 10 yearsNew car max 160 gCO2/km (staggered) €220mn1 year 2008 – 2009Proposal for extension 2010

NL: €750–1,000 cars€750–1,750 LCVs> 13 years (petrol)> 9 years (diesel) €65mn2009-10

P: €1000/1250> 8 years, > 13 years, New car max 140 gCO2/km5 months 2009

L: €1500/1750> 10 yearsNew car max 150 gCO2/km1 months 2009

E: Plan 2000E: €2000Plan VIVE: interest free loan (€10,000 max)> 10 years, or 250,000 km car max 5 years, max 140gCO2/km1.5 years 2008–2010

I: €1500 – 3000 cars€2500 – 6500 LCVs> 9 yearsNew car max 130-140gCO2/km11 months 2009

GR: new scheme announced:€1500 – 3200 cars€2000 – 3700 LCVs€7000 – 13000 HDVs2009 – 2012

SK: €2000 > 10 years€22.1 mn9 months 2009

RO: €1000 > 10 yearsMax 60,000 vehicles11 months 2009

A: €1500 > 13 yearsNew car min Euro 4€45 mn9 months 2009

D: €2500 further tax rebate for Euro 5/6 cars > 9 yearsMin Euro 4, max 1 year €5 bn1 year 2009

Source: ACEA

While scrappage provided the largest and most-discussed boost in Germany, other countries showed significant boosts as well. We estimate that scrapping programmes in WE provided nearly 3mn units of sales, and had a relatively minor positive affect in Eastern Europe. However, as critics of the programmes point out, at least some of these sales would have occurred anyway in 2009. To estimate the base underling rate we assume that, depending on the design of the programme, between 30% and 35% of the buyers would have found their way into showrooms with or without scrappage incentives. Of the remaining scrappage sales, we estimate that c50% were incremental sales and c50% a pull-forward of 2010E sales in 2009E.


8 December 2009 11

Figure 3: Barclays Capital 2009E scrappage model

2008A 2009E Scrappage

boost

% of scrappage sales that 'would have occurred' in

2009E

% of scrappage sales pulled

forward from 2010E

2009E pro forma ex scrappage

Germany 3,090 3,750 1,600 25% 35% 2,550

UK 2,132 1,860 285 35% 30% 1,675

Italy 2,162 2,000 400 30% 35% 1,720

France 2,050 2,150 390 30% 35% 1,877

Spain 1,161 880 200 30% 35% 740

Rest of WE 2,966 2,460 50 30% 35% 2,425

W Europe 13,561 13,100 2,925 10,987

New EU States 1,179 870 40 30% 30% 842

Pan-EU 14,740 14,000 2,965 11,829

Turkey, Russia & FSU 3,809 1,934 - - - 1,934

Total Europe (inc Russia) 18,549 15,934 2,965 13,763

YoY chg(total Europe) -4.3% -14.1% -25.8%

Source: ACEA, JD Powers and Barclays Capital

Backing out the estimated 2.0mn scrappage sales that otherwise would not have occurred in 2009E (assuming c.30% of total 2.9mn scrappage sales would have occurred in the year even without scrappage), brings the underlying base rate of sales to 11.0mn in 2009 in WE and 13.8mn in total Europe (incl. Russia) – a YoY decline of 19% in WE and 26% overall.

Note that while our 14% decline forecast for 2010E will bring sales down to 11.3mn, far lower than the comfortable 14mn run rate of recent months in WE (sales even reached a SAAR of 15mn in Oct 09), the -25% cumulative decline this will imply between 2008A and 2010E is on a par with levels at which the markets cleared prior to scrappage incentive interventions (as per Figure 4 below), and in line with the 25% declines seen in the US prior to cash for clunkers.

Figure 4: YoY change in monthly W European car sales

-30%-25%-20%-15%-10%

-5%0%5%

10%15%20%

Jan-

07

Mar

-07

May

-07

Jul-

07

Sep-

07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-

08

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-

09

Sep-

09

EU(15) + EFTA(3) Source: ACEA, Barclays Capital

As opposed to the scrappage fuelled headline number of

13.1m 09E, we believe that the true underlying rate is closer to 11mn in WE– a far deeper hole

from which to climb out.


8 December 2009 12

We believe that extension of scrappage programmes could provide a further scrappage boost of 1.0mn units in 2010E, offsetting some of the payback from pull-ahead sales, and underlying euro area growth of 1.6% could provide an additional boost of, optimistically, 5% to auto sales, to bring total sales to 11.3mn in WE and 14.3mn in total Europe – well below the consensus range which we estimate at c.12.2mn to 13mn in WE.

Figure 5: Barclays Capital 2010E scrappage model

2009E 2010E Pay back from

2009 scrappageContinued

scrappage boostPro forma ex

scrappage change in base

demand

Germany 3,750 2,543 -560 400 2,703 6%

UK 1,860 1,773 -85 100 1,759 5%

Italy 2,000 1,746 -140 80 1,806 5%

France 2,150 1,934 -137 100 1,971 5%

Spain 880 744 -70 60 754 2%

Rest of WE 2,460 2,579 -18 50 2,547 5%

W Europe 13,100 11,320 -1,010 790 11,540 5%

New EU States 870 932 -12 60 884 5%

Pan-EU 14,000 12,252 -1,020 850 12,500

Russia 1,934 2,132 2,132 5%

Total Europe (inc Russia) 15,934 14,385 850 14,556

YoY chg total Europe -14.1% -9.7%

Source: Barclays Capital

A few scrappage schemes still to play out in 2010 but not likely to offset payback from sales pulled forward in 2009

While the bulk of scrappage programmes played out in 2009, at least a few countries still have budget or plans for scrappage in 2010. In France, a government draft budget document is set to reduce the incentive support from the current level of EUR1,000 to EUR700mn on 1 January 2010 and to EUR500mn on 1 July 2010. The UK recently extended its scheme by an additional 100,000 vehicles and it is expected that the Spanish and Italian schemes will also be extended to some degree.

Although, the German programme ran out of money in early September, and there has been no suggestion that an extension can be expected, there is still expected to be some carryforward into 2010E as the scheme was based on orders placed rather than on deliveries. In particular, we believe that VW likely as an order book of at least 500,000 units, of which 300,000 are likely to be delivered in 2010 in the winter and early spring.

In addition, but not assumed in our analysis, German automakers appear to be pressing for a subsidy programme (or changes in personal taxation of company-provided cars to reflect actual price vs. list price) focused on company fleets, a segment in which sales fell from the ‘normal’ range of 1.8mn units to 1.2mn units in 2009.

At the same time, while we believe the scrappage programmes, particularly in Germany, attracted many customers who would not otherwise have bought a new car, some sales were undoubtedly pulled forward from 2010E as consumers accelerated purchases. As a result, the net impact of scrappage in 2010 will be negative – a likely boost of 0.8mn from continuation of scrappage schemes but battling a headwind of 1.0mn sales that were pulled forward from 2010E into 2009.

2010 sales of 11.3mn likely in W Europe - limited scrappage

boost and modest euro area economic growth


8 December 2009 13

Figure 6: W European historical car sales, 1970-2012E (units in 000’s)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010E

W European Car Market Total ('000)

'73-74-13%

'79-81-8%

'92-93-17%

'00-03-7%

08A-10E-25%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010E

W European Car Market Total ('000)

'73-74-13%'73-74-13%

'79-81-8%

'79-81-8%

'92-93-17%'92-93-17%

'00-03-7%

'00-03-7%

08A-10E-25%

08A-10E-25%

Source: ACEA, JD Powers, Barclays Capital

Macro boost of 4-5% is somewhat optimistic given history of rebounds

We are somewhat optimistically assuming that underlying base sales (that is, 2009 stripped of scrappage distortions) will grow 5% - yet we still remain significantly below consensus with our 11.3mn (-13.6%) estimate for Western Europe in 2010E (we believe consensus is expecting only an 8-10% decline).

In looking at prior cycles in Western Europe, the average rebound was 3.4% or on average 0.7x the prior year’s downturn. The sharpest rebound was 6% in 1994, after a near-17% decline in 1993.

Figure 7: Western European historical & forecast car sales cycle, 1970A-2015E

W EU car market

total ('000) YoY change %

1973 9,431 1.2% 1974 8,160 -13.5% 1975 8,416 3.1% 1976 9,532 13.3%

1979 10,636 3.9% 1980 10,107 -5.0% 1981 9,817 -2.9%

1982 10,004 1.9% average of prior first year rebounds 1983 10,460 4.6% 3.4% 1984 10,152 -2.9% average of prior 2nd year rebounds 1985 10,664 5.0% 7.0%

1986 11,684 9.6%

1990 13,517 0.5% 1991 13,416 -0.7% 1992 13,498 0.6% 1993 11,252 -16.6% 1994 11,938 6.1% 1995 12,034 0.8%

Source: JD Powers, ACEA, Barclays Capital

Overall, across the 2008-10 cycle, we expect a decline in

Western Europe of 25% (with the aid of scrappage incentives),

only slightly worse than the 1992-93 downturn but

significantly worse than other post 1970 downturns.


8 December 2009 14

Moreover, regression shows that for every 1% change in euro area GDP, automotive registrations will change about 1.8%. Note while we examined other macro factors, including income growth, unemployment and interest rates, GDP alone provided the best (albeit, with 23% R-squared, a somewhat weak) fit.

Figure 8: Barclays Capital estimates for real GDP growth, 2008-2010E

Real GDP Real GDP % over previous period, SAAR % annual change

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 2008 2009 2010

Europe and Africa -12.2 -0.6 3.2 3.1 1.8 2.1 2.1 1.5 -4.3 1.9

Euro area -9.6 -0.7 2.3 1.6 1.6 1.7 1.6 0.6 -3.8 1.6 Germany -13.4 1.3 3.6 2.9 3.0 2.5 2.0 1.0 -4.8 2.6 France -5.4 1.1 2.5 1.4 0.8 1.1 0.9 0.3 -2.1 1.2 Italy -10.4 -2.0 2.7 0.7 1.0 1.4 2.0 -1.0 -4.8 1.2 Spain -6.2 -4.2 -0.1 -0.3 -0.7 0.3 0.1 0.9 -3.5 -0.3 Netherlands -10.3 -4.4 -0.4 2.5 3.1 3.1 2.7 2.0 -4.4 2.0

United Kingdom -9.6 -2.3 -1.0 2.2 2.0 1.9 1.7 0.6 -4.6 1.3 Sweden -3.7 0.6 0.8 1.2 2.0 2.4 2.7 -0.4 -4.7 1.8 EM Europe & Africa -19.7 0.4 7.3 7.0 2.1 3.0 3.2 4.0 -5.3 2.9

Czech Repub. -15.7 -2.7 4.4 6.2 0.4 2.8 3.5 3.0 -4.7 2.0 Hungary -8.5 -7.8 -3.2 -1.4 0.8 1.2 2.4 0.5 -6.5 0.5 Poland 1.2 2.0 0.8 0.0 1.6 2.4 3.2 4.9 0.9 2.9 Russia -26.8 -2.2 17.0 13.7 1.5 2.5 3.3 5.6 -7.5 3.0


Overall, our BarCap economics colleagues forecast 1.6% growth in WE GDP for 2010, with growth rates varying from -0.3% in Spain to 2.6% in Germany. Using the 1.8x multiplier (where every 1% change in Real GDP correlates to 1.8% change in auto registrations as per Figure below), this implies registration growth of 3.4% (consistent with prior rebounds), with the strongest growth in base demand likely in Germany – which had the greatest scrappage distortion. However, when we back out the likely scrappage payback in 2010E, we are left to forecast just 2.5mn units, somewhat below consensus expectation of 2.7mn units in Germany in 2010E.

There are still a few scrappage schemes to play out in 2010 but not likely to offset payback from sales pulled forward in 2009 (see scrappage section later in this report).

Figure 9: EU car registrations vs. real GDP YoY Chg (%), 1995-2009

Figure 10: Correlation of EU car registrations to real GDP (YoY Chg %), 1995-2009

-15%

-10%

-5%

0%

5%

10%

15%

Dec

-95

Dec

-97

Dec

-99

Dec

-01

Dec

-03

Dec

-05

Dec

-07

-6%-5%-4%-3%-2%-1%0%1%2%3%4%5%

Car Registrat. Real GDP

-15%

-10%

-5%

0%

5%

10%

15%

-6% -4% -2% 0% 2% 4% 6%

Real GDP (YoY % chg)

Reg

istr

atio

ns (

yoy

% c

1% change in Real GDP = 1.8% change in registrations

R2 = 0.23

Source: ACEA, Haver Analytics, Barclays Capital Source: Haver Analytics, Barclays Capital

10


8 December 2009 15

EU PRODUCTION TO WEAKEN SEQUENTIALLY BUT GLOBAL GROWTH PICKS UP

Supported by the region’s scrappage programmes, European production in 2009 recovered somewhat from 3.4mn units in 1Q09 to an estimated 4.4mn in 4Q09. However, with most government incentives ending in 2009, the region is likely to experience some payback from pulled forward demand, in our view. As a result, we expect European production to decline in 2010 to 15.9mn units, down from an estimated 16.2mn units in 2009.

Figure 11: Pan European production (including LCVs and Russia): 2007-2015E (and quarterly), units in mn

5.8 5.94.8 4.0 3.4 4.2 4.2 4.4 4.0 4.0 3.7 4.2

21.720.5

16.2 15.917.1

18.619.8

21.0 22.3

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

E

1Q10

E

2Q10

E

3Q10

E

4Q10

E

2007

2008

2009

E

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

Source: CSM, Barclays Capital

At the same time, we expect North American production to increase from an estimated 8.6mn units in 2009 to 11.2mn units in 2010, as recent US sales performance suggests signs of a recovery. Indeed, US sales have improved modestly in 4Q09, with November SAAR reaching 10.9mn, up from 10.5mn in October and a 1H09 average of 9.6mn. Furthermore, North American production volumes in 2009 were depressed due to the industry’s need to correct for excess inventory, which we do not expect to reoccur in 2010.

Figure 12: North America light vehicle production – 2007-15E (and quarterly), units in mn

3.5 3.5 3.0 2.71.7 1.8 2.4 2.7 2.5 2.9 2.6 3.1

15.1

12.6

8.6

11.212.5

13.5

15.014.4 14.5

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

E

1Q10

E

2Q10

E

3Q10

E

4Q10

E

2007

2008

2009

E

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E



8 December 2009 16

On a global basis, we expect light vehicle production to increase, fuelled by a rebound in North America and continued growth in BRIC countries.

Figure 13: Global light vehicle production – 2008-15E

12.6 8.6 11.2 12.5 13.5 15.0 14.4 14.5

20.516.2 15.9 17.1 18.6 19.8 21.0 22.3

7.510.5 11.1 11.9

13.4 14.2 14.8 15.314.4

10.712.1

13.013.5

14.2 14.1 13.81.7

1.61.7

1.92.0

2.1 2.1 2.2

3.7

3.63.9

4.14.7

5.0 5.3 5.65.0

4.65.3

6.06.9

7.4 7.8 8.165.4

55.761.1

66.672.6

77.7 79.5 81.7

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

South Asia

South America

Middle East/Africa

Japan/Korea

Greater China

Pan Europe

North America



8 December 2009 17

DESPITE LONG-TERM DOWNSIZING, MID-TERM GROWTH IS IN VOLUME C AND ABOVE SEGMENTS AS SCRAPPAGE DISTORTION FADES

In addition to boosting volumes well above their base run rate, the European scrappage programmes, by design, shifted mix dramatically downward. Going forward, however, even acknowledging the longer-term shift to A (city car, eg, Fiat Panda) and B class (subcompact, eg, VW Polo, Ford Fiesta) vehicles, in the mid-term we expect mix to somewhat renormalize in a recovering market. As a result, we believe the fastest growing segments through 2012 will actually be volume C segments (compact, eg, VW Golf, Ford Focus) and C/D and D segments (midsize, eg, VW Passat, Ford Mondeo).

Figure 14: Western Europe mass vehicle segment mix 2008 vs. 2009E

10.5%

29.5%31.4%

8.0%

13.7%

33.1%

29.6%

7.0%

A B C D

2008 2009

10.5%

29.5%31.4%

8.0%

13.7%

33.1%

29.6%

7.0%

A B C D

2008 2009

Source: JD Powers, Barclays Capital

Figure 15: A-C volume segment market share and YoY chg by country, 2009E vs 2008A

A segment B segment C segment

2008 segment market share 10.5% 29.5% 31.4%

YoY Chg by Country:

France 0.9% 0.5% 0.0%

Germany 1.7% 4.2% 1.6%

Italy 0.4% 0.2% -0.2%

Spain -0.1% -0.4% -0.8%

UK 0.3% -0.2% -1.0%

Other 0.3% -0.8% -2.5%

Memo: total change 3.2% 3.7% -1.8%

2009 segment market share 13.7% 33.1% 29.6%


The 320bp one-year increase in A share and 370bp change in B share is well ahead of the longer term trendline shift to smaller vehicles. For example, the A segment only grew by 350bp between its 2003 low of 6.4% and 2008, while was actually flat in the ten year period 1998-2008. The B segment grew by 400bp over the same ten-year period.

In 2009, in the volume market, the A segment gained 270 points of segment share over 2008, the

B segment 360bp while C segment lost 180bp and

The shift in segment share across Europe can more than be accounted for by the scrappage

programmes in the top five countries – for example, the

German programme alone contributed 4.2 share points in

2009 to the overall European increase in volume B segment

share vs. 2008.


8 December 2009 18

Figure 16: Western Europe overall segment share 1994-2008

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

A B C D E

Source: JD Power, Barclays Capital

Figure 17: A to D volume market segment share 2006-12E

2006 2007 2008 2009 2010 2011 2012

A - Basic 8.2% 8.4% 10.5% 13.7% 11.4% 11.5% 12.0%

B - Small 29.9% 29.7% 29.5% 33.1% 31.4% 32.8% 32.8%

Memo: A + B 38.1% 38.1% 40.0% 46.8% 42.8% 44.3% 44.8%

C - Lower Medium 31.4% 31.9% 31.4% 29.6% 32.6% 31.8% 31.0%

D - Upper Medium 9.6% 8.4% 8.0% 7.0% 6.7% 6.2% 6.1%

Memo: C + D 41.0% 40.3% 39.5% 36.6% 39.3% 38.1% 37.1%

Memo: A - D 79.1% 78.4% 79.4% 83.4% 82.1% 82.4% 81.9%


Figure 18: Change in volume by segment 2009 to 2012E

-413

-540

-45

89

38

-4

-600 -500 -400 -300 -200 -100 0 100 200

A - Basic

B - Small

C - Lower Medium

D - Upper Medium

E - Executive

F - Luxury

Change in units 2009-12E (000)


As a result, the A and B segments are likely to shrink by

almost 1mn units, while the D segment should grow slightly

and the C segment remain flat.

Going forward, we expect some renormalisation of mix.


8 December 2009 19

SCRAPPAGE AND LOAN PROGRAMMES PRESERVED EXCESS CAPACITY

With well-known restrictive labour relations in most Western European countries, the European market has been plagued by excess capacity, with capacity utilisation averaging only 84% from 2001 to 2007.

Figure 19: European capacity utilisation rates, 2001-2015E vs 6yr historical average

70%

75%

80%

85%

90%

95%

2001 2003 2005 2007 2009E 2011E 2013E 2015E

European Capacity Utilisation Historical average


Government interventions during the downturn of 2009 forestalled the capacity reduction that might normally accompany a sharp cyclical downturn. European capacity (excluding Russia and Turkey) stood at 20.8mn units in 2005, and is likely to close 2010 at 18.2mn units. Note that the downturn has only resulted in 3.9mn units of capacity reduction in the overall European market, whereas production has fallen by 4.3mn units during the same period, causing utilisation rates for the industry as a whole to stall at below 80% until 2011E and below the 6-year historical average for the overall market of 84% until at least 2012E.

Figure 20: European total production & capacity 2005A-2010E (mn)

Figure 21: European overall market production vs capacity utilisation 2005-2015E

12.0

14.0

16.0

18.0

20.0

22.0

24.0

2005 2006 2007 2008 2009E 2010E

European Capacity (mil) European Production (mil)

13.0

14.0

15.0

16.0

17.0

18.0

19.0

2008 2010E 2012E 2014E70.0%

75.0%

80.0%

85.0%

90.0%

European Production (LHS) European capacity

Source: CSM, Barclays Capital Source: CSM, Barclays Capital


8 December 2009 20

Volume capacity particularly hampered by government interventions

Having averaged 83% from 2001 to 2007, capacity utilisation for the volume market is not likely to surpass 80% until 2012 and will not reach 90% levels until 2015, when production volumes are expected to attain near pre-crisis levels.

Figure 22: European volume* production vs capacity utilisation 2008-2015E

10.0

11.0

12.0

13.0

14.0

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Mill

ions

70.0%

75.0%

80.0%

85.0%

90.0%

European Volume Production (LHS) EU volume capacity utilisation % (RHS)

10.0

11.0

12.0

13.0

14.0

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Mill

ions

70.0%

75.0%

80.0%

85.0%

90.0%

European Volume Production (LHS) EU volume capacity utilisation % (RHS)

Source: CSM, Barclays Capital *total market ex-BMW, Mercedes, Porsche Audi & JLR/Tata

Figure 23: European volume capacity utilisation by company type 2008-2015E

65%

70%

75%

80%

85%

90%

95%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

European Volume* US based Asian Volume avg

Source: CSM, Barclays Capital *European volume comprises Fiat, PSA, Renault & Volkswagen ex-Audi

PSA is likely to achieve the highest utilisation rates in the market in the next three years – peaking at 95% in 2012E, even trumping premium peers, helped partly by rationalisation schemes at Aulnay and Rennes and also by upcoming model launches in C-segment. However, we believe that PSA’s cost-cutting efforts are well understood by the market and that by contrast, RNO, which has the greater amount of savings to achieve since it has one of the lowest capacity utilisation rates in the market, will actually surprise the market by its ability to significantly increase the scale-effects with Nissan (see RNO section later in this report).

Although EU volume manufacturers will maintain

utilisation above market average from 2010E onwards, they will

be overtaken by their Asian peers in 2011E and will still

linger below the 85% level until 2014. Government intervention

to hinder major capacity reduction plans, eg, €6bn loaned

by govt to PSA and RNO dependent on no plant

closures in France.


8 December 2009 21

Premium manufacturers suffer from lack of demand but more room to manoeuvre

The premium market suffers from overcapacity, albeit not to the same extent as its volume peers, nor was capacity artificially preserved by explicit government intervention. Capacity utilisation fell to 77% in 2009 (from a six-year historical average of 91%), but could reach 88% by 2012E and 95% by 2015, spurred by rebound in export demand and modest expansion of European demand.

Figure 24: European premium* production vs capacity utilisation 2008-2015E

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Mill

ions

75.0%

80.0%

85.0%

90.0%

95.0%

EU Premium Production EU premium capacity utilisation % (RHS)

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Mill

ions

75.0%

80.0%

85.0%

90.0%

95.0%

EU Premium Production EU premium capacity utilisation % (RHS)

Source: CSM, Barclays Capital *BMW, Mercedes, Audi, Porsche & JLR/Tata

The premium market excess capacity is not evenly distributed -- BMW, Audi and Porsche are likely to maintain capacity utilisation in 2010 of 93%, 85% and 84%, while Mercedes and Tata (Jaguar/Land Rover) will stall at 74% and 77% respectively. In terms of units, Daimler likely will have about 370,000 units of excess capacity, compared to 80,000 for BMW and 135k for Audi.

Figure 25: European volume OEM excess capacity by company 2010e

Figure 26: European volume OEM capacity utilisation by company 2008-2015E

74

96

125

126

239

268

287

354

401

885

0 200 400 600 800 1,000

Hyundai

Honda

Nissan

Toyota

General Motors

Fiat

PSA

Renault

Ford

Volkswagen

55%

60%

65%

70%

75%

80%

85%

90%

95%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Fiat PSA Renault VW ex-Audi


Although average historical utilisation at 91% far exceeds

that of the volume market, excess capacity will linger for premium OEMs in 2010 with

only 81% utilisation.


8 December 2009 22

Figure 27: European premium excess capacity by company 2008-2015E

Figure 28: European OEM capacity utilisation by company 2010E

78

369

133112

17

0

50

100

150

200

250

300

350

400

BMW Daimler Audi Tata Porsche

Excess production capacity

Thou

sand

s

78

369

133112

17

0

50

100

150

200

250

300

350

400



Thou

sand

s

60%

65%

70%

75%

80%

85%

90%

95%

100%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

BMW MercedesAudi Tata/JLRPorsche Premium avg



8 December 2009 23

SCRAPPAGE SCHEMES MAY HAVE HOOKED EUROPEAN CONSUMER ON INCENTIVES SETTING UP PRICING PRESSURE

Perhaps the most insidious unintended consequence of the scrappage programmes may be a potential breakdown in pricing discipline in key European markets, leading to more transparent pricing and a price shopping, deal seeking consumer as has developed in the US.

Historically, the weak capacity utilisation in Western Europe has been counterbalanced by relatively robust pricing in the volume car market. In particular, the more concentrated major markets, France and Germany, which have local companies with high volume share, tend to have higher list prices than less concentrated markets such as Spain and the UK without indigenous manufacturers.

Figure 29: European list prices for volume segments A-D, Jan 2009

€ 7,613€ 9,272

€ 9,462€ 9,703€ 9,810

€ 9,993€ 10,286

€ 10,454€ 10,498€ 10,548€ 10,681€ 10,747€ 10,799€ 10,870€ 10,878

UKMELCYFI

NLIT

ATESFRLUD

BEPTIE

List price (Euros)

Source: European Commission

According to a recent report published by the European Commission1, real (ie, inflation-adjusted) car prices declined in 23 out of 27 Member States between January 2008 and January 2009. The EU price index for cars (reflecting nominal prices paid by consumers, including VAT and registration taxes) decreased by 1.3%, against a 1.8% rise in overall prices, translating into a fall in real car prices of 3.1%. In new Member States, consumer are even more price-sensitive as lower incomes have historically led a high share of consumers to opt for second-hand cars, manufacturers are facing particularly price-sensitive consumers. As a result, real prices in EE countries decreased on average (-6.9%). However, this data only assesses manufacturer list prices and does not take account of the recent surge in incentive discounts which differ from country to country and have a significant impact on manufacturer profitability.

A combination of a dramatic fall in consumer demand and a sea change in consumer pricing expectations, induced by both government scrappage schemes and companies’ own attempts to drive down overstockage via pricing promotions, also mean that manufacturers are not now in a position to significantly raise prices in countries affected by currency devaluations. Prior to the scrappage programmes, manufacturer rebates had been minimal and sporadic in most countries, and rarely widely advertised. But the various scrappage

1 European Commission “Car Price Report at 1.1.2009”, published June 2009

Even excluding the effects of scrappage incentives across the

EU, real car prices fell 3% in 2008 and are likely to have fallen

even more sharply in 2009E


8 December 2009 24

programmes led to intense media coverage around the level of government 'cash on the bonnet,' which ranged from €1,000 to €2,500 per vehicle, with even additional rebates in some countries for the most environmentally friendly cars.

Figure 30: Scrappage incentive levels per vehicle by country (EUR)

€ 1,000€ 1,120

€ 1,500

€ 2,000

€ 2,500

France UK Italy Spain Germany

Source: ACEA & Country statistics

In addition, some manufacturers would offer up to double the government cash in heavily advertised offers.

Figure 31: Examples of incentivised cars in Germany (prices in €)

Vehicle Fiat Panda Fiat Grande Punto Fiat Bravo

Base price 9,690 11,550 15,950

Govt rebates 2,500 2,500 2,500

OEM rebates 2,200 2,360 3,460

TOTAL rebates 4,700 4,860 5,960

Net price 4,990 6,690 9,990

Advertising pitch Weniger ist mehr, weniger ist besser, weniger ist genial

[Less is more, less is better, less is genius]

Vehicle Nissan Micra Nissan Note Nissan Qashquai

Base price 11,220 16,790 20,190

Govt rebates 2,500 2,500 2,500

OEM rebates 4,000 4,000 4,000

TOTAL Rebates 6,500 6,500 6,500

Net price 4,720 10,290 13,690

Advertising pitch Jetzt bis zu 6,500 € prämien sichern

[Save up to €6,500 - secure your rebate now]

Source: Company data, trade press


8 December 2009 25

In Germany list prices are currently about 5.5% more than the average for the 16 euro-denominated countries, which allows greater flexibility for manufacturer/dealer incentive packages. The German government’s “Umweltprämie” or €5bn scrappage incentive programme ran out of money in September, prompting carmakers to step up discounts yet further: for instance Ford is currently offering zero-percent financing and a €2,000 rebate for the Focus, Fiesta and Ka compacts in Germany and a package of cheap loans, insurance and servicing provides savings of as much as €1,330 on most VW models.

Figure 32: Government scrappage schemes have led automakers to heavily boost their own incentives in 2009

Avg OEM incentives in Germany Oct 2009 Sep 2009 Dec 2008

Avg incentive/car (€) 2,485 2,292 €2,528

Incentive as % of list price (%) 11.6% 10.7% 11.8%

Source: KBA, Barclays Capital

In the US market, a somewhat analogous anti-recession incentive programme (albeit only company funded) led to a marked deterioration in pricing that persisted for years, leading to a relatively profit-less recovery. After the events of September 11, showroom traffic slowed dramatically, threatening US automotive production further in the midst of the post tech-boom recession. To restart its own sales (and arguably to reboot a key part of the US economy), GM launched its 'Keep America Rolling' programme, offering zero-percent financing. The programme, quickly matched by both domestic and transplant manufacturers, led to a marked rebound in sales, which rose from a SAAR of 16.1mn units in September 2001 to a peak of 21.3mn in the following month -- as average incentives rose steadily from US$1.5/car in early 2001 to $2.7k in October and to over $3k/car in late 2002.

Figure 33: US monthly sales (000’s) and monthly incentives per car (US$)

150

200

250

300

350

400

Jan-

02

Jul-

02

Jan-

03

Jul-

03

Jan-

04

Jul-

04

Jan-

05

Jul-

05

Jan-

06

Jul-

06

Jan-

07

Jul-

07

Tho

usan

ds

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

US monthly car sales Avg monthly incentive per car (US$)

Source: Autodata

However, sales fell in late 2001 due to payback. Rather than accepting the decline, US auto makers boosted incentives to restart sales (and, at least for GM to 'run the business for cash' to cover fixed costs), leading to three years of rising incentives but stalled sales.


8 December 2009 26

Figure 34: US monthly sales (000’s) and monthly incentives per car (US$), 2002-07A

150

200

250

300

350

400

Jan-

02

Jul-

02

Jan-

03

Jul-

03

Jan-

04

Jul-

04

Jan-

05

Jul-

05

Jan-

06

Jul-

06

Jan-

07

Jul-

07

Tho

usan

ds$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

US monthly car sales Avg monthly incentive per car (US$)

Source: Autodata

While manufacturers attempted to the boost list price to offset some of the incentives, the real price of new cars and trucks fell steadily until this past year, when manufacturers finally resisted the urge to cut prices in the face of falling demand in the US market.

Figure 35: Real new car CPI -- US market 1996-09A, YoY chg %

-10%-8%-6%-4%-2%0%2%4%6%

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Rea

l CPI

YoY

Chg

%

New car New truck

Source: US Bureau of Labor Statistics

In Europe, as incentive programmes wind down, pricing stands on the cusp of following the profitless American-style path. Already in 2009, pricing appears to have deteriorated by 3.1% on a real basis.

With residual value depreciation comprising c47% of the total cost of vehicle ownership, a softer new vehicle pricing environment will also likely have a knock on negative effect on second-hand pricing which will impact both consumers and leasing-exposed manufacturers alike.


8 December 2009 27

Figure 36: Total cost of ownership for average vehicle in Europe

Residual value depreciation

47%

Fuel14%

Insurance12%

Interest8%

Tyres5%

Taxes5%

Maintenance8%

Admin1%

Source: EurotaxGlass

Our recent conversations with OEMs, as well as the 3Q09 result discussions, revealed pricing concerns across the spectrum. Three points stood out:

Luxury makers reported that pricing in key markets was coming under pressure as consumers and dealers demanded rebates to match those offered under scrappage programmes to volume makers. To date, this pressure has been only partially buffered by new model roll outs.

Volume manufacturers point to manufacturer incentives being frequently added on top of government incentives, with intense competition during many programmes. With the conclusion of scrappage program in Germany, manufacturer incentives are remaining constant, albeit with falling order volumes – leading to risks of future price cuts.

Most manufacturers believe pricing pressure is more acute in the retail market, while corporate programme buyers show less price sensitivity.

Figure 37: Euro area new and second-hand car prices, YoY chg %

Figure 38: Selected European country new car nominal CPI

-8%

-6%

-4%

-2%

0%

2%

4%

Jan-

08

Mar

-08

May

-08

Jul-

08

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-

09

Sep-

09

France Germany Italy

Spain Euro zone

-3%

-2%

-1%

0%

1%

2%

3%

4%

Jan-

08

Mar

-08

May

-08

Jul-

08

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-

09

Sep-

09

UK Germany France NL

Source: Eurostat Source: Eurostat


8 December 2009 28

Figure 39: Manheim index of residual values, YoY chg %

Figure 40: Average European OEM monthly incentive spending per car in US market, Jan 01 to date (US$)

-15%

-10%

-5%

0%

5%

10%

15%

Nov

-06

Feb-

07

May

-07

Aug

-07

Nov

-07

Feb-

08

May

-08

Aug

-08

Nov

-08

Feb-

09

May

-09

Aug

-09

$0$500

$1,000$1,500$2,000$2,500$3,000$3,500$4,000$4,500

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

European Car Average US incentive

Source: Manheim Consulting Source: Autodata


8 December 2009 29

CURRENCY SHIFTS PRESSURE US AND UK IMPORTS

Arguably, the aggressive fiscal and monetary stimulus taken by the UK and US governments have led to a weakening of their currencies, creating further pressures (perhaps unintended) on importers into those markets. Over the last year, the pound has fallen 15% relative to the euro while the US dollar has slipped 12%.

Although of the European OEMs BMW has one of the highest proportions of sales in the UK and US markets (22% of sales in the US market and 11% in UK), but with a significant manufacturing presence in the UK and the US, BMW is also one of the most insulated in our coverage to both the US and UK. All other manufacturers have meaningful pound sterling exposure, especially after PSA chose to close its UK, Ryton plant. Fiat, PSA and VW’s low proportion of sales in the US (and VW’s plant in Mexico and future plant Tennessee, US) leave them less exposed to the US dollar weakness, while Nissan is partially hedged. Of all OEMs, Daimler has the biggest FX exposure – being exposed both to the US and to the UK and with very little natural hedging in either region.

Figure 41: Current EURUSD spot rates painful to importers

Figure 42: EURUSD forward rates remain close to US$1.5

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

EURUSD

1.4741.4761.478

1.4801.4821.4841.486

1.4881.4901.492

1 day 1month

3month

9month

2 year

EURUSD forward rates

Source: Datastream Source: Datastream

Figure 43: Current EURGBP spot rates painful to importers

Figure 44: Forward rates do not imply GBP burden will ease

0.50

0.60

0.70

0.80

0.90

1.00

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

EURGBP

0.885

0.890

0.895

0.900

0.905

0.910

0.915

1 day 1month

3month

9month

2 year

EURGBP forward rates



8 December 2009 30

WE FAVOUR THOSE WITH DOMINANT HOME MARKET C & D POSITIONS

Overall the WE volume market is highly fragmented, but home country hegemony offers profit pockets in Western Europe The threat of a pricing war could upset what has been a historically attractive pricing environment in Europe driven by local market concentration. While WE appears fragmented on an overall basis (HHI under 1,500, no player over 25% share), many volume segment/country markets (eg, B car in Italy) are highly concentrated, offering competitors pricing power.

Figure 45: Overall Western European market shares

Group 2006 2009E Share change

Porsche-VW Group 18.9% 20.7% 1.8%

PSA Group 13.8% 14.1% 0.3%

Renault-Nissan Group 11.8% 11.1% -0.8%

Ford Group 10.1% 10.4% 0.3%

Fiat Group 8.3% 9.5% 1.2%

GM/Opel 9.8% 8.7% -1.2%

Daimler Group 5.8% 5.4% -0.3%

Toyota Group 5.6% 5.1% -0.6%

BMW Group 4.7% 4.5% -0.2%

Hyundai Group 3.2% 3.6% 0.3%

Honda Group 1.5% 1.7% 0.1%

Other 6.3% 5.4% -1.0%

Concentration index (HHI) 1039 1101

Top 3 share 44.6% 45.9% 1.3%


Segment/country concentration favours home country incumbents -- despite years of EU directives aimed at harmonization, home country preferences in volume market remain strong (eg, French have 40% share in France, VW 30% share in Germany, Fiat 45% share in Italy A/B car, Ford still seen as UK local firm with 25% of C market).

WE appears fragmented on an overall basis (HHI under 1500,

no player over 25% share)


8 December 2009 31

Figure 46: “Home company” share by country/segment – volume market*

69%

28%

51%

67%

24%

42%

59%

44%

13%

70%

47%

1%

France Germany Italy

A B C D

Source: JD Powers, Barclays Capital (ie, market share of domestic manufacturers -- RNO & PSA combined share in France; Smart & VW in Germany; Fiat in Italy)

As a result, several pockets of concentration remain, offering pricing power if the lead competitor chooses to set a price umbrella, and other competitors follow suit. Note we measure concentration using the Hehrfindal-Hirschman index (HHI), which is the sum of the squares of the market shares of the participants. An HHI of 10,000 would be a one-layer market (10000 = 100*100 ), while a two-player market with each player at 50% share would have an HHI of 5000 (= 50*50 + 50*50). A market over 1,800 is considered concentrated, while a market over 3,000 is considered highly concentrated.

Figure 47: Concentration ratios & degree of concentration by country/segment – volume OEMs

HHI Ratios: A B C D E G sports MPV Pickup SUV Van

France 2945 2429 2112 3184 4311 3133 2715 2821 2753 2745

Germany 1343 1359 2483 2655 3528 4263 2211 3176 3021 2152

Italy 3050 2199 1260 2643 9450 3688 1885 2855 2627 2020

Spain 2090 1497 1523 1740 3431 3853 1442 2783 2104 2019

UK 1715 1280 1483 1614 4444 3293 2256 2938 2267 1705

Degree of concentration::

France MEDIUM MEDIUM MEDIUM HIGH HIGH HIGH MEDIUM MEDIUM MEDIUM MEDIUM

Germany LOW LOW MEDIUM MEDIUM HIGH HIGH MEDIUM HIGH HIGH MEDIUM

Italy HIGH MEDIUM LOW MEDIUM HIGH HIGH MEDIUM MEDIUM MEDIUM MEDIUM

Spain MEDIUM LOW LOW LOW HIGH HIGH LOW MEDIUM MEDIUM MEDIUM

UK LOW LOW LOW LOW HIGH HIGH MEDIUM MEDIUM MEDIUM LOW

Note: Concentration ratio is sum of squares of market shares, over 1800 is considered concentrated, over 3000 highly concentrated Source: JD Powers, Barclays Capital


8 December 2009 32

Figure 48: Key Western European markets: estimated volume by segment 2011E (units)

0.00.10.20.30.40.50.60.70.80.91.0

A - Basic B - Small C - LowerMedium

D - UpperMedium

VanM

illio

ns

France Germany Italy Spain UK Source: JD Powers, Barclays Capital

The luxury market remains highly concentrated -- which has in the past supported strong pricing. The risk going forward is the three-party concentration can quickly pivot from price discipline to a price war as each of the three vie for share in a flat market.

Figure 51: Western European premium market shares by segment/manufacturer, 2009E

B C D E F G MPV SUV Total

BMW Group 100.0% 30.5% 35.2% 26.4% 39.5% 8.2% 12.4% 30.5% 33.7%

Daimler Group 0.0% 33.7% 24.5% 37.0% 35.9% 44.0% 80.5% 22.1% 29.4%

Porsche-VW Group 0.0% 35.8% 37.0% 30.0% 17.9% 44.0% 0.0% 36.8% 33.3%

Renault-Nissan Group 0.0% 0.0% 0.2% 0.0% 0.0% 1.2% 7.1% 0.4% 0.3%

Tata Group 0.0% 0.0% 1.6% 5.9% 5.1% 1.5% 0.0% 6.7% 2.3%

Toyota Group 0.0% 0.0% 1.5% 0.5% 1.5% 0.1% 0.0% 3.5% 0.9%

Other 0.0% 0.0% 0.0% 0.2% 0.0% 1.0% 0.0% 0.0% 0.1%

2009 units (000) 132 541 536 263 29 196 17 237 1,954

HHI 10,000 3,347 3,210 3,005 3,200 3,939 6,679 2,828 3,112


Figure 49: Concentration ratios by country: A and B volume segments

Figure 50: Concentration ratios by country: C and D volume segments

2,945

1,343

3,050

2,090

1,715

2,429

1,359

2,199

1,497

1,280

France

Germany

Italy

Spain

UK

Concentration index

A B

2,112

2,483

1,260

1,523

1,483

3,184

2,655

2,643

1,740

1,614

France

Germany

Italy

Spain

UK

Concentration index

C D

Source: JD Powers, Barclays Capital Source: JD Powers, Barclays Capital


8 December 2009 33

SCALE AND COMMONALITY PROVIDES BUFFER AGAINST UNINTENDED CONSEQUENCES

OEM strategies are starkly similar, implying the real differentiation will be in starting point and execution (especially versus market expectations). Virtually every OEM articulates four common strategic themes:

1. Reengineer operational and administrative costs short term

2. Seek/leverage global scale and parts commonality (that is, reach 1mn units per platform) via market share gains (especially around product cadence), alliance, merger, internal cooperation to lower engineering and product costs

3. Drive fuel efficiency/carbon reduction via both ICE incremental improvements and varying degrees of hybridization

4. Pursue growth in emerging markets, especially BRIC countries

In our view, the strategic lever most impactful to differentiating performance over the mid-term is likely to be the quest for global scale and commonality – especially as OEMs face the unintended consequences of scrappage programmes in the form of potential pricing pressures and sticky labour costs and capacity. Moreover, the competitive edge is likely to evolve from simply posting 1mn unit scale in key volume platforms, to exploiting the scale through common engineering and parts specifications (not just purchasing volumes).

Global OEMs are evolving through three distinct phases in their search for scale and commonality of cost savings In phase 1, scale-driven procurement, OEMs sought bulk purchasing price discounts from suppliers. Rather then offering any 'win win' solutions, OEMs threatened to pull business from suppliers unless demands for price cuts were met. The global element was not focused around engineering commonality, but simply a brute threat that if supplier fails to cut price in one region, the OEM would punish the supplier by taking away business in another region. This approach was first launched in the early 1990s at GM and then VW (brought over by Jose Ignacio Lopez de Arriortua, whom VW hired away from GM). While saving up to 20% on purchased parts, with annual price downs of 1 to 2 percent, the procurement approach helped OEM profits - although at the expense of supplier profits and arguably innovation. Moreover, the procurement approach failed to address internal OEM costs such as engineering. The sheer brute force of Phase 1 favoured the manufacturers with the largest global production volumes (eg, GM), regardless of the degree of commonality across platforms and geographies.

Most OEMs are still pursuing varying degrees of phase 2, platform commonality. In this approach, OEMs seek to commonise parts across vehicles within a platform -- at first, variants within a region and then in vehicles across regions. For the OEM, platform commonality unlocks engineering savings, up to 60 percent on the common vehicles depending on how far out the scale curve. If extended globally, OEMS can gain further benefit from leveraging lower cost production sites and by supporting smaller-run variants to address niche segments. Platform commonality can be win-win for suppliers, who can similarly leverage their engineering and tooling costs across larger runs, as well as more easily move production across different plants in different geographies. Japanese OEMs such as Honda, with their export driven approach, were early leaders, although virtually all OEMs are at some stage of phase 2. Overall savings can range from 5-10%, depending on scale and commonality.


8 December 2009 34

Figure 52: Estimated impact of increasing commonality

Cost components Est. costPotential

improvement Pro forma margin

impact (bp) Comment/lever

Impact on Product Cost view

EBIT 5%

Labour 5% 20% 100 Capacity utilisation

Materials and engineering 90%

of which:

Vehicle-specific 25% 5% 124 Design/procurement

Powertrain 25% 10% 248 Engineering/mfg

Additional common components 11% 7% 79 Design/procurement

Modular architectures 29% 15% 439 Engineering/mfg

Product potential 889

Impact on Capex/ER&D view

Capex and R&D/sales 5.5% 70% 385

Engineering 3.0% 60% 180

Total ER&D 8.5% 66% 565

Source: Company reports, Barclays Capital

In phase 2, scale by platform is the starting point. Nissan-Renault have the largest scale in the B segment, with over 2mn units in 2011, albeit with we believe little commonality across vehicles. VW, with 1.5mn units, is likely the leader when volume and commonality are considered together. Despite its strength in the B segment in Europe, Fiats lack of an Asian or integrated North America presence has it trailing most competitors (except for GM) in the B segment.

Hyundai has, somewhat surprisingly, the largest scale in the C segment, with close to 2mn units in 2011. VW and Ford are second and third, although Ford will only get to a truly common platform in C car with the Focus relaunch in 2010/11.

Figure 53: Global production of major B segment platforms by OEM (000’s units) – 2011E

1,460

926

2,103

745

1,1121,215

378

796596

Fiat TYPE 169(500)

Ford B2e(Fiesta)

GM GlobalGamma(Aveo)

Honda GSP(Fit)

Hyundai PB(Accent)

PSA PF1 (207) Renault-Nissan B(Versa)

Toyota NBC-2(Yaris)

VWPQ24/PQ25

(Polo)

Europe Asia Middle East/Africa North America South America



8 December 2009 35

Toyota’s strength lies in the D segment, with over 3.6mn units on the Camry platform, followed at a distinct second and third by Hyundai and Honda.

Phase 3 involves modular architectures - that is, parts commonality not just within a platform, but across platforms (and across geography). By further driving down the scale curve additional efficiencies result - as well as lowering the overall complexity of the organisation and supporting manufacturing flexibility (multiple platforms on the same assembly lines). VW is acknowledged by competitors as the global benchmark for modularity, with plans to compress to two sets of modules (MQB for traverse, generally volume) and MLB for longitudinal, generally premium)

Figure 54: Global production of major C segment platforms by OEM (000’s units) – 2011E

1,814

1,3011,3721,132

1,946

1,4261,352

1,788

1,369

Fiat TYPE 199(Punto)

Ford C1(Focus)

GM GlobalDelta (Cruze)

Honda C5(Civic)

Hyundai HD(Elantra)

PSA PF2 (308) Renault-Nissan C(Sentra)

Toyota MC-C(Corolla)

VWPQ35/PQ36

(Golf)

Europe Asia Middle East/Africa North America South AmericaSource: CSM, Barclays Capital

Figure 55: Global production of major D segment platforms by OEM (000’s units) – 2011E

315 9341,048 1,208 1,221

233

994

3,685

842

Fiat C-Evo(Milano)

Ford CD4(Fusion/Mondeo)

GM GlobalEpsilon (Malibu)

Honda D-5(Accord)

Hyundai NF/CM(Sonata)

PSA PF3 (408) Renault-Nissan D(Altima)

Toyota MC-M(Camry)

VW MLB (A4)

Europe Asia Middle East/Africa North America South AmericaSource: CSM, Barclays Capital

When intra- and cross-platform commonality is considered in, for example, the C segment, we believe that VW, with its modular approach, and Hyundai, with its scale of the common Elantra platform, capture the greatest scale economies. While Renault/Nissan has scale, it appears to have not driven true platform cost sharing, highlighting an opportunity to drive the alliance to the next level Both PSA and Fiat fall short on sheet scale, although both are likely to have a moderate level of commonality.


8 December 2009 36

Figure 56: Manufacturer’s scale vs estimated commonality – key C platforms

Honda

Ford

ToyotaFiat

GMPSA

Renault-Nissan

VWHyundai

0 1,000 2,000

Scale - units 000

Deg

ree

of c

omm

onal

ity HIGH

MED

LOW



8 December 2009 37

SECTOR VALUATION – 2-NEUTRAL

Our 2-Neutral rating for the sector is based on our below-consensus view for the 2010 sales and pricing environment offset by the attractive valuations when pivoting to 2011 revenue and earnings power.

We believe 2010 will be a disappointing year for European automakers as the unintended consequences of scrappage programmes play out across Western Europe. Sales will likely decline by 13.6% -- far greater than market expectations which we believe are looking for an 8-10% decline -- while production will likely slip below 16mn units. The drop in production will highlight the endemic overcapacity that the scrappage programmes and loan programmes preserved. To make matters worse, pricing will come under pressures as discount-addicted customers and dealers demand and receive automaker-funded rebates.

Against this difficult 2010 backdrop, valuations for 2010 appear fairly valued, although with a broad range across our coverage. In terms of EV/sales, the 2010 EU sector average of 27% (range from 7% to 44%), is only just below the 2002-08 historical average of 28% (excluding Porsche).

Figure 57: 2010E EV/sales

18%

44%

35%

7%11%

40%

27% 27% 27%

48%

BMW

AG

Dai

mle

r A

G

Fiat

SpA

Peug

eot

SA

Ren

ault

SA

Pors

che

Vol

ksw

agen

(Ord

s)

Vol

ksw

agen

(Pre

fs)

EU s

ecto

rav

erag

e

Ford

Mot

orC

o.



8 December 2009 38

Figure 58: 2002-08 historical average EV/sales (sector avg excl Porsche)

41%35%

28%

13% 11%

124%

38% 38%28% 27%

BMW

AG

Dai

mle

r A

G

Fiat

SpA

Peug

eot

SA

Ren

ault

SA

Pors

che

Vol

ksw

agen

(Ord

s)

Vol

ksw

agen

(Pre

fs)

EU s

ecto

rav

erag

e

Ford

Mot

orC

o.


In terms of industrial EV/industrial EBITDA, the 2010 EU sector average of 2.6x (range from 1.1x to 5.4x) is somewhat more below the 2002-08 historical average of 3.3x.

Figure 59: 2010E EV/EBITDA

1.5x

5.4x4.9x

1.1x 1.2x1.9x 2.2x 2.2x

2.6x

7.3x

BMW

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8 December 2009 39

Figure 60: 2002-08 historical average EV/EBITDA

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Given depressed 2010 earnings, for P/E the 2010 EU sector average of 30.7x (excluding Fiat, PSA, RNO) (range from 12x to 59x) is well above the 2002-08 historical average of 12.8x.

Figure 61: 2010E PE multiples

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8 December 2009 40

Figure 62: 2002-08 average PE multiples

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While fairly valued on 2010, as cost reductions mount and sales recover in 2011, driving earnings recovery, 2011 valuations are more enticing. In terms of EV/sales, the 2011 sector average of 22% (range from 7% to 40%) is below the 2002-08 historical average of 28% (excluding Porsche).

Figure 63: 2011E EV/sales multiples

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Similarly, in terms of industrial EV/Industrial EBITDA, the 2011 sector average of 2.0x (range from 0.9x to 4.1x) is well below the 2002-08 historical average of 3.3x.


8 December 2009 41

Figure 64: 2011E EV/EBITDA multiples

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For P/E the 2011 sector average of 12.2x (range from 7.3x to 25.4x) is also below the 2002-08 historical average of 12.8x.

Figure 65: 2011E PE multiples

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8 December 2009 42

BMW – POTENTIAL FOR FURTHER COST CUTS DRIVES 1-OVERWEIGHT RATING

Given the pricing, demand, and currency pressures we expect to continue in the premium market, we favour companies that can deliver and retain near- and mid-term cost reductions ahead of market expectations. BMW is a well-understood story as regards its upcoming model cadence sweetpoint (with a raft of model launches in train, beginning with the 5-series in 2Q10E and building up to 1- and 3-series in 2011-12E). Nevertheless, we believe the market is underestimating the company’s potential for deeper and further cost savings, both as a result of the full roll-out of its modular strategy and as a consequence of increased flexibility regarding employee costs due to an ageing workforce and extensive use of temporary workers. While Daimler’s “in excess of €4bn” savings target for 2009E has been widely touted, BMW’s management has kept more tight-lipped about its cost-saving potential of late. We believe this more cautious approach has led the market to dismiss the full potential of “Strategy #1” and hence undervalue the BMW share. Moreover, while not part of Strategy #1, BMW’s more extensive manufacturing presence in the UK and US provides more of a natural currency hedge offsetting the strength of the euro.

We are initiating coverage with a 1-Overweight rating and a €41 price target, implying 25% potential upside from current levels.

Key share price drivers:

Positives:

Cost-saving potential enhanced by advanced age of workforce & modular strategy

Above-average capacity utilisation rates & planned global capacity enhancements

Product cadence brings youthful models in 2010E & further boosts CO2 credentials

Price/mix strength from new models to mitigate pricing pressures in overall market

US exposure and low exposure to scrappage incentives to drive above market volume growth

Balance sheet strength - cash generation potential aided by strong model mix

Risks to our 1-Overweight view:

Failure to deliver expected cost savings

Increased negative earning impact if USD/GBP were to weaken further

Lingering effects of low value leasing contracts

1-Overweight, €41 price target We are initiating coverage with a 1-Overweight rating, due to the company’s potential for cost savings via its modular strategy and increased workforce flexibility which will combine with a youthful product mix to drive above consensus EBIT growth. A strong core balance sheet and superior cash generative ability should further support share price accretion. We value the BMW share based on an average of EV/sales and PE metrics at historical and peer average multiples, which lead us to our €41 price target (please see the valuation section for further details).

BMWG.DE / BMW GY




Price (04-Dec-2009) €32.75



8 December 2009 43

Figure 66: BMW – headline data and valuation multiples, 2008-2012E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 53,197 48,371 47,903 50,530 52,595

Reported EBIT 921 395 1,829 3,232 3,882

EBIT margin (%) 1.7% 0.8% 3.8% 6.4% 7.4%

BC EPS € 0.51 0.24 1.64 3.14 3.84

Consensus EPS € -- 0.30 1.61 3.01 2.88

EV/sales (%) 20% 20% 18% 18% 16%

EV/EBITDA 1.1x 2.2x 1.5x 1.1x 0.9x

P/E ratio (%) 60.2x 137.0x 20.0x 10.4x 8.5x

Source: Company data, Barclays Capital *FactSet consensus data

BMW has unappreciated cost reduction opportunities

While we agree that pricing pressures for the market as a whole and the likely 2010E effects of weak sterling and US dollar exchange rates for euro-denominated exports have not been fully understood by the investment community, we feel that BMW is better placed than its premium rivals to overcome these burdens. With investors now increasingly looking beyond 2009E to the prospects for 2010 and 2011, we believe that BMW has positioned itself for a faster than expected recovery in its automotive EBIT.

BMW will, in our view, pursue four interrelated cost levers that should drive EBIT improvement of €1.4bn in both 2010 and 2011 even in the face of these external burdens:

BMW will benefit from its push for modularity, especially as the new 5- and 7-series (which share a platform) are rolled out, with the savings flowing in lower materials costs.

BMW can better capture productivity savings as it has a substantially longer-tenured workforce that provides greater potential for further headcount reductions.

Costs should also benefit from stronger capacity utilisation.

BMWs expanding global manufacturing footprint not only supports growth but also provides better natural hedging relative to Daimler.

Figure 67: BMW Auto EBIT walkdown, 2008A (€mn)

Figure 68: BMW forecast Auto EBIT walkdown, 2009E (€mn)

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8 December 2009 44

Modularity to lower costs as product line refreshed While important for the top-line growth and as a buffer against pricing (which we discuss later), BMWs strong product cadence will, in our view, also demonstrate the cost savings associated with BMW’s push (as at VW and, to a lesser extent, Daimler) for greater modularity and commonality across vehicles.

BMW product launches start in earnest in 4Q09 with 5-series GT and X1 coming on line, sharply followed by new 5-series in 2Q10 and X3 in 4Q10. As a result, BMW is likely to be the fastest improver in the sector in terms of average product age. We expect this to boost market share but also to enable the full effects of the €4bn in material cost savings targeted under Strategy #1. As the new modular strategy is rolled out across new products, material costs & R&D should increasingly become shared across all model series on a platform, rather than on a standalone model basis. With the company emphasising the potential for up to 80% commonality between products on the two main platforms (1-/3-series /X1/X3 produced on the ‘small car’ platform and 5-/6-/7-series working off the ‘large car’ platform), we expect to see the back-end loaded savings from this modular strategy starting to ramp up from 2010E. We believe that these savings are not yet widely credited by consensus forecasts.

Figure 69: BMW forecast new model introduction schedule, 2009-2012E

BMW Group 2009E 2010E 2011E 2012E

BMW 2Q: Z4

4Q: X1 & 5 GT

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4Q: X3

1-series

3 GT & 6-series

3-Series

Mini 2Q: Cabrio Countryman 4 Coupe Roadster

Rolls-Royce Coupe RR Ghost

Source: JD Power, trade press, company data and Barclays Capital

Ageing workforce to boost productivity Strategy #1 targets a reduction of €6bn in costs by 2012E, €2bn of which are to come from fixed costs/R&D. Although BMW has not been grabbing the headlines so recently with announcements on headcount reductions like its close peer Mercedes, the naturally older age of its workforce should enable BMW to quietly achieve the majority of its targeted personnel savings over the next three years via natural attrition alone. With c20% of all workers aged >50 years (vs. 2% at Mercedes), the company has much more flexibility to manoeuvre its workforce. Additionally, BMW has historically relied much more heavily on temporary workers (hence the ability to reduce the workforce by 10,000 workers in 2008, of which 60% were temporary workers) which provides additional flexibility to react speedily to changes in production. Temporary workers are paid a similar hourly rate to their permanent counterparts but (according to Jens Koehler, chief workers' representative at the Leipzig plant and an official with IG Metall) receive about two-thirds of the total monthly compensation due to receiving fewer benefits than regular staff. Although the current BMW workforce is comprised of only a tiny percent of temporary workers, the scope to rehire on a temporary basis when production begins to recover, will position the company well from a fixed cost perspective.


8 December 2009 45

Figure 70: BMW average worker age vs. Daimler (years)

Average age (yrs) Percent over 50 yrs (%)

BMW hourly 39.6 17

BMW salaried 42.4 25

Daimler hourly 40.8 2

Daimler salaried 41.6 2

Source: Company data

Unlike Daimler, BMW is no longer using Kurztarbeit (short-time work) as it ramps up production (auto production exceeded sales by almost 10k units in 3Q09) in preparation for a raft of model launches beginning in Q409. This production build, combined with moves to draw down dealer inventory, in an effort to improve BMW’s longer-term pricing power, explains the larger-than-expected Q3 loss in the Auto division. However, we note that Q4 results will likely be flattered by the sales momentum from 5-series GT and X1 launches thus matching sales outturn more closely to production levels and cost absorption should be boosted further by full 5-series model launch in 2010E.

Sector leading capacity utilisation BMW is already working at above average (for premium peers) capacity utilisation in 2009E but is set to achieve the best in sector utilisation rate of 93% in 2010E (vs premium sector average of 81% and volume average of 79%), with the lowest level of excess capacity units of all peers. This further encourages us to favour the share over its closest luxury rival.

BMW is closing the gap on competitors not only with its increased commonality of components, but also in the scale-stakes via well-targeted alliances: such as its small engine cooperation with PSA and its cooperation with DAI on purchasing & hybrid development.

Figure 71: BMW production (mn) & capacity utilisation (%) vs average for premium market, 2008A-15E

Figure 72: European premium excess capacity, 2010E (000s)

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8 December 2009 46

Figure 73: BMW & Mercedes production units, indexed to 1997

90100110

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BMW MercedesSource: CSM, Barclays Capital

Global scope to aid competitiveness and help shield against FX burdens Although Germany remains BMW’s biggest single market (accounting for 21% of unit sales YTD 09 see Figure 74), 19% of unit sales are US-based and the Chinese market is now BMW’s fourth-largest market, after recording 25% growth YTD in 2009. We therefore credit the company with the ability to sell 46,000 extra vehicles in 2010E, despite European sales likely flat. A recovery in the US market and exposure to more resilient emerging markets, combined with its good model mix will provide an expected 5% growth in units in 2010E – we forecast a positive impact on EBIT of €500mn (see Figure 78 below).

Figure 74: BMW geographical breadth (YTD 09 unit sales)

Germany21%

Rest of WE25%

USA19%

China7%

Japan3%

ROW25%


Last month BMW announced plans to build a second plant in China with JV partner Brilliance (the existing plant has produced BMW 3-series and 5-series vehicles since 2003 with current production capacity of 41,000 pa. Production at the second plant is due to commence early 2012E and to increase total Chinese capacity to 100,000 units, thus giving the company a stronger foothold in this fast-growing market and providing a natural hedge to exchange rate fluctuations.


8 December 2009 47

Figure 75: BMW estimated plant capacity, 2010E (000s)

Region Production 2010E Capacity 2010E Capacity utilisation %

Germany* 870,000 920,000 95%

UK 217,300 244,500 89%

US (Spartanburg) 135,000 270,000 50%

China (Shenyang)** 75,000 75,000 100%

Other*** 130,000 143,000 91%

BMW Total (ex-JVs) 1,300,000 1,397,000 93%

Source: CSM, Company data, Barclays Capital *Regensburg, Dingolfing, Munich, Leipzig, ** JV with Brilliance, *** S Africa and JV with Magna Steyr in Austria

While our thesis still stands that the market is underestimating the likely negative EBIT impact in 2010E from USD and GBP FX rates, we believe that BMW’s efforts to expand, or at the very least maintain, its capacity reach in UK and US markets will shelter it to some degree from the worst of the FX effect. Mini brand’s Oxford and Rolls Royce Goodwood plants in the UK (providing 245,000 units of British capacity in 2010E) and the Hams Hall engine plant, provide natural hedging from negative GBP currency effects, despite only an estimated 30-40% sourcing of components locally. Likewise, BMW’s Spartanburg plant (which will ramp up to 270,000 pa capacity in 2010 in preparation for the next generation X3 launch), with 70% locally sourcing, provides shelter from the vagaries of the USD. With the US market likely to rebound ahead of the scrappage-restrained European market in 2010E, BMW’s 21% revenue share should also set it apart from some of its volume peers.

Figure 76: BMW estimated naturally hedging protection for USD and GBP, 2010E

Units Sale Value in US$ mil

N Am sales 276,085 14,500 N Am production 133,000 8,100 100% 100% 133,000 8,100 Net vehicle imports/(exports) 143,085 8,700 N Am engines imported 133,000 500 Net currency position US$ 9,200 Natural hedging percentage 44%

Units Value in UK£ mil

UK sales 123,500 4,021 UK production 206,000 3,090 est. % of local sourcing 35% 35% Implied UK production sourced in UK£ 72,100 1,082 Net vehicle imports/(exports) 51,400 2,939 UK engine production 350,000 1,050 Net currency position UK£ 1,889 Natural hedging percentage 55%

Source: Company data, Barclays Capital

Our calculations of exposure to the GBP and USD, based on 44% natural hedging in the US and 45% in UK (vs. only 40% and 0% respectively for Mercedes) lead us to forecast a €450mn negative EBIT impact from FX in 2010E - enough to more than wipe out the effects of non-personnel based productivity savings but still €450mn below our estimates for Mercedes’ FX exposure due to its lower natural hedging buffer.


8 December 2009 48

Figure 77: BMW estimated GBP and USD exposure, 2008-2012E (units as stated)

2008 2009E 2010E 2011E 2012E

North American volume (units) 303,190 238,000 276,085 289,900 300,000 Natural hedging volume in USD (%) 45 48 44 52 52 Net currency position, N Am (US$ mn) 8,800 7,500 9,200 8,000 8,400 Financial hedging volume (%) 95% 90% 60% 20% 0% Spot rate 1.47 1.40 1.49 1.49 1.49 Estimated effective rate 1.36 1.35 1.42 1.48 1.49

US$ impact on EBIT (€mn) (210) 40 (370) (220) (30) UK volume (units) 154,000 130,000 123,500 136,500 153,100 Natural hedging volume in UK£ (%) 53 54 55 55 55 Net currency position, (UK£ mn) 2,350 1,890 2,180 2,300 2,390 Financial hedged volume (%) 90% 90% 60% 20% 0% Spot rate 0.80 0.90 0.90 0.90 0.90 Effective rate 0.70 0.79 0.84 0.89 0.90

UK£ impact on EBIT (€mn) (120) (310) (150) (150) (30)

TOTAL XR impact on EBIT (€mn) (330) (300) (480) (370) (60)


Market forecasts underestimate BMW’s potential Whilst consensus numbers are currently expecting a €4bn YoY EBIT delta for Daimler in 2010E (admittedly aided by an estimated €2bn of improvement in trucks), market assumptions for BMW estimate only a €1.3bn improvement, despite the company’s superior model mix. Although we believe the market as a whole has not taken full account of the likely FX and raw material negatives for the autos sector in 2010E, neither do we think they have fully credited the likely modular savings resulting from new model roll outs at BMW. Our own forecasts incorporate €1bn of improvement in BMW’s Automobile segment (€1.5bn at group level) – of which €900mn relates to cost efficiencies, €540mn to volume improvement and €345mn to the price/mix effects of new 5- and 7-series. €750mn of additional FX and raw material costs still allow an EBIT margin improvement of 240bp YoY, on our estimates.

Figure 78: We forecast an EBIT delta of €1bn at BMW Autos in 2010E

BMW Auto cost walkdown (Delta) - €mn 2009E 2010E 2011E 2012E

Prior year Auto EBIT 690 (307) 728 1,958

Volume (1,428) 540 600 425 Memo: additional volume (units) (183,104) 69,205 76,558 54,492

Fixed costs: Price/Mix (1,300) 345 300 - Raw materials & other input costs 100 (270) - - Productivity/efficiency 400 500 500 550 Currency (300) (480) (370) (60) Personnel, SG&A, R&D 620 400 200 - Other (incl risk provisions in 2008) 911 - - - Total change in fixed costs 431 495 630 490 Operating margin delta (997) 1,035 1,230 915

Current year Auto EBIT (307) 728 1,958 2,873

EBIT margin (%) -0.7 1.7 4.3 6.1



8 December 2009 49

5-series launch will buffer against pricing trends Whilst we remain convinced that the full effects of pricing weakness have also yet to be factored in to market numbers for 2010E, we believe that BMW’s youthful product cycle and its substantial destocking of dealers should stand the group in good stead from a pricing perspective. Although ill-discipline in pricing has spread to even the luxury end of the market, with consumer expectations skewed by a year of discounts from both governments and manufacturers alike, the launch of the all-new 5-series range in 2010E should form some degree of buffer from pricing negatives.

The company’s Q309 results call was characterised by cautious commentary on price – management blamed luxury peers for pricing new models over-competitively in a grab for market share. We agree that pricing across the board will come under pressure in 2010E and therefore assume that BMW’s existing models will suffer €1k/vehicle pricing erosion – a €500mn negative effect. However, we also credit the company with the ability to price both its 5-series and 7-series models ahead of its predecessors, thus providing a likely €600m positive contribution to EBIT, and more than compensating for the price erosions on other models. Likewise, the mix impact from these new models launching in what we view as the fastest growing segments in Europe (small car segments are likely to flounder post-scrappage), should provide a further €245mn boost to EBIT, based on a €5,000/vehicle incremental EBIT margin (our breakdown of the price/mix impact on 2010E’s EBIT is given at Figure 79 and Figure 81 below). Our forecasts do not assume any benefit from an improvement in mix to corporate buyers, though we expect these to return to the market in greater numbers in 2010E. However, with the 5-series launch also heralding the beginning of a more modular strategy, bringing greater commonality across model ranges, we are convinced that EBIT/vehicle is set to improve significantly at BMW even in a weak demand and pricing environment.

Figure 79: Positive mix and pricing effects of new models should more than compensate for negative pricing on other models

5-series 7-series Other models Total BMW

Additional vehicles of new model (units) 150,000 30,000

Additional price/vehicle (€) 3,000 5,000

EBIT impact (€mn) 450 150 600

Negative price/vehicle (€) (1,000)

EBIT impact (€mn) (500) (500)

Est. mix effect* 200 45 245

Total BMW EBIT delta (€mn) 345

Source: Barclays Capital; *assuming €5,000 EBIT contribution/vehicle for incremental 5-series sales and €15,000 for 7-series


8 December 2009 50

History of cash generation to further support valuation

Since scrappage did not boost the luxury market significantly in 2009E, it is a well-argued thesis that the luxury market will be better protected from any scrappage pull-back effects felt in 2010E. Whilst, as with product cadence, we believe that this issue has already been factored in to current share price, we agree that BMW is positioned to outperform the overall market from 2010E onwards. If the volume effects are already well understood, the cost benefits of the company’s strong positioning in environmentally friendly products (via its Efficient Dynamics range), such that it still remains at least 12 months ahead of competitors in the R&D spending stakes, should yet provide further upside to the share.

Cost savings to ramp up from 2010E onwards

One of the reasons why we believe that investors are not crediting enough future cost savings at BMW is because, unlike Daimler, BMW does not give useful quarterly walkdowns of its Auto EBIT margin, so investors have much less visibility over cost-savings achieved already in YTD 09A. Neither has BMW been flaunting its cost-saving potential as widely in the press as its German peer, preferring instead to caution investors on the likely external burdens to 2010E earnings. Although productivity improvements of €80mn were more than offset by volume and price/mix negatives at BMW in 2008 and we expect a similar story in 2009E (as scrappage incentives pushed consumers to lower mix cars, leaving volumes at the premium end of the market muted), we do forecast a further €1bn gross cost savings in 2009E (as per Figure 78 above). Of these, €400mn relates to internal productivity measures and €620mn to personnel savings – the likely full-year effects of 10,000 employee departures in 2008 (of which 4,000 were permanent workers). This should provide some buffer against the -€1.3bn price/mix effect and -€1.4bn volume negative in 2009.

In 2010 and 2011, as discussed above, we expect savings from increased modularity and improved productivity to combine with the effects of natural attrition in the workforce and a more positive volume and mix environment, to help the Autos business return to above 4% margins (though still some way from historical peak and Strategy #1 target of 8-10%).

Figure 80: BMW Auto EBIT walkdown 2010E (€mn)

Figure 81: BMW price/mix walkdown 2010E (€mn)

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8 December 2009 51

Putting it together – EBIT and cash flow

With a five-year historical average FCF in the industrial business of €1.7bn per annum and average net industrial debt of €6bn during the same period (€7.8bn at 3Q09), BMW has typically been a share favoured by leverage-averse investors. Despite an overly aggressive strategy in its leasing business which led to €2bn of lease book writedowns in 2008A and likely three years of low value leases coming through the system, we believe BMW remains an attractive stock due to its superior balance sheet. Although downgraded one notch by rating agencies, the debt has an A- rating from S&P, the highest in the auto sector, giving it easy access to credit to support the funding of its financial services business.

Figure 82: Solid cash generation drives steady rise in net cash, €mn

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Rating We are initiating coverage with a 1-Overweight rating, believing that BMW’s potential for cost savings via its modular strategy and increased workforce flexibility will combine with a youthful product mix to drive above consensus EBIT growth. A strong core balance sheet and superior cash generative ability should further support share price accretion.

Valuation methodology We value the BMW share based on an average of EV/sales and PE metrics at historical and peer average multiples:

EV/sales

BMW has historically traded at a five-year average of 39% EV/sales, although it dipped to 20% during the credit crisis of 2008 and at current market price is only trading at 18% 2010E EV/sales on our estimates. By comparison luxury peer DAI’s historical average is 42% and on our estimates is currently trading at 44% 2010 EV/sales. We believe that the current BMW share price significantly undervalues the share based on this valuation metric, especially since we remain below consensus on our top-line forecasts for BMW in 2010E.


8 December 2009 52

Figure 83: Below consensus revenue estimates but expecting higher margins

2010E Barclays Consensus Variance

Revenue (€mn) 47,903 50,734 -5.6%

EPS (€mn) 1.64 1.57 4.3%

Source: FactSet consensus, Barclays Capital

Daimler’s exposure to the higher-rated truck sector should imply a higher multiple to BMW but we note that in reality the market has tended to discount this truck exposure, viewing both companies at similar multiples. Using its own historical average of 39% implies BMW should trade at €50/share.

P/E

Historically BMW has traded at an average of 11x P/E (vs 13x at Daimler and 9.8x for the sector as a whole). Looking out to 2011E, when we expect autos markets to have normalised to a greater degree, our above consensus EBIT estimates put BMW at only 10x at the current share price. We believe that the company should trade at its historical level of 11x, from which we derive a price of €35.

Figure 84: At current price BMW is undervalued on EV/sales

Figure 85: BMW cheap in comparison to DAI

15%

20%

25%

30%

35%

40%

45%

50%

2004 2005 2006 2007 2008 2009E 2010E 2011E 2012EEV/Sales at current price

5 year historical avg

0%

10%

20%

30%

40%

50%

60%

70%

80%

2000 2002 2004 2006 2008 2010E 2012E

DAI EV/Sales BMW EV/Sales

0%

10%

20%

30%

40%

50%

60%

70%

80%

2000 2002 2004 2006 2008 2010E 2012E


Source: Company data, Barclays Capital Source: Company data, Barclays Capital


8 December 2009 53

Figure 86: Other than during the recent downturn, BMW has historically traded at 11x PE

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

PE at current price 8 year historical avg


A weighted average of both these valuation metrics leads us to set a €41 price target for the share, implying 25% upside from current market price.

Figure 87: BMW key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E

Valuation multiples at current price

Industrial EV/sales (%) 40 39 20 20 18 18 16 Industrial EV/clean EBITDA 2.7x 3.0x 1.1x 2.2x 1.5x 1.1x 0.9x Industrial EV/clean EBIT 5.7x 6.0x 3.8x 114.2x 5.4x 3.2x 2.4x P/E 9.3x 9.4x 60.2x 137.0x 20.0x 10.4x 8.5x FCF yield (%) 21.1 26.9 33.6 26.8 29.1 23.7 29.5 Price/sales (%) 54 52 38 43 44 41 40 Price/book 1.4x 1.4x 1.0x 1.2x 1.3x 1.4x 1.2x Dividend yield (%) 1.7 2.4 1.0 0.9 1.5 2.1 2.1 Valuation multiples at €41 price target

Industrial EV/sales (%) 40 39 20 20 18 19 17 Industrial EV/clean EBITDA 2.7x 3.0x 1.1x 2.6x 1.8x 1.3x 1.1x

Industrial EV/clean EBIT 5.7x 6.0x 3.8x 133.4x 6.4x 3.8x 2.8x

P/E 9.3x 9.4x 60.2x 146.5x 21.4x 11.1x 9.1x

FCF yield (%) 21.1 26.9 33.6 25.1 27.2 22.1 27.6 Price/sales (%) 54 52 38 46 46 44 42 Price/book 1.4x 1.4x 1.0x 1.24x 1.44x 1.45x 1.32x

Dividend yield (%) 1.7 2.4 1.0 0.9 1.4 2.0 2.0



8 December 2009 54

Risks to price target Risks to our price target are as follows:

External risk – macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

Risks to leasing book – we believe that the worst is now behind the company in relation to writedowns on its financial services leasing book but were second hand prices to fall significantly and cause further writedowns to residual values, BMW’s larger than average financial services penetration would result in a greater downside risk than for peers.

Credit perspective Barclays Capital credit analysts, Rob Perry and Darren Hook, also rate BMW Overweight believing that while there are risks to BMW's ratings, with Moody's particularly at risk of downgrading to high BBB, BMW could remain low A through next year, given their expectations for moderate revenue growth, potential for further cost reductions, and belief that current provisioning in Financial Services is adequate.


8 December 2009 55

Figure 88: BMW Group income statement, 2006A-2012E

Year-end December (€mn) 2006 2007 2008 2009E 2010E 2011E 2012E

Revenues 48,999 56,018 53,197 48,371 47,903 50,530 52,595

Cost of sales (37,660) (43,832) (44,323) (40,631) (39,329) (40,424) (41,550)

R&D (2,544) (2,920) (2,825) (2,515) (2,395) (2,526) (2,630)

Gross profit 8,795 9,266 6,049 5,224 6,180 7,579 8,415

Memo: gross margin (% of sales) 17.9% 16.5% 11.4% 10.8% 12.9% 15.0% 16.0%

Sales and administrative costs (4,972) (5,254) (5,369) (5,079) (4,551) (4,548) (4,734)

Other operating income & expenses 227 200 241 250 200 200 200

Reported profit before financial result (EBIT) 4,050 4,212 921 395 1,829 3,232 3,882

Non-recurring income and (expenses) (2,423) 0 0 0 0

Clean profit before financial results (EBIT) 4,050 4,212 3,344 395 1,829 3,232 3,882

Memo: clean EBIT margin (%) 8.3% 7.5% 6.3% 0.8% 3.8% 6.4% 7.4%

Financial result 74 (339) (570) (200) (300) (300) (300)

Profit before tax 4,124 3,873 351 195 1529 2932 3582

Memo: PBT margin % 8.4% 6.9% 0.7% 0.4% 3.2% 5.8% 6.8%

Taxes (1,250) (739) (21) (39) (459) (880) (1,074)

Tax rate (ex RRExch. tax-free gains) 34% 19% 6% 20% 30% 30% 30%

Net profit 2,874 3,134 330 156 1,070 2,052 2,507

Memo net profit ex-non recurring 2,722 3,134 2,608 156 1,070 2,052 2,507

Attributable to MI 6 8 6 6 6 6 6

Net profit attributable to shareholders 2868 3126 324 150 1064 2046 2501

Net margin % 5.9% 5.6% 0.6% 0.3% 2.2% 4.1% 4.8%

EPS 4.39 4.80 0.51 0.24 1.64 3.14 3.84

No of shares (average, 000s) 654 654 653 653 653 653 653

DPS (Euros) 0.70 1.06 0.30 0.30 0.50 0.70 0.70

Segmental Revenue:

Automobiles 47,767 53,818 48,782 41,341 42,316 45,215 47,446

Motorcycles 1,265 1,228 1,230 1,119 1,139 1,168 1,196

Financial services 11,079 13,940 15,725 15,411 14,948 15,247 15,552

Miscellaneous/consolidations (11,112) (12,968) (12,540) (9,500) (10,500) (11,100) (11,600)

Group revenues 48,999 56,018 53,197 48,371 47,903 50,530 52,595

Segmental reported EBIT:

Automobiles EBIT 3055 3450 690 (307) 728 1,958 2,873

Motorcycles EBIT 75 80 60 50 57 64 72

Financial services EBIT 689 717 -216 324 448 762 778

Reconciliations 231 -35 387 328 596 447 159

Profit before financial result (EBIT) 4050 4212 921 395 1829 3232 3882

Segmental reported EBIT margins:

Automobiles EBIT margin 6.4% 6.4% 1.4% -0.7% 1.7% 4.3% 6.1%

Motorcycles EBIT margin 5.9% 6.5% 4.9% 4.5% 5.0% 5.5% 6.0%

Financial services EBIT margin 6.2% 5.1% -1.4% 2.1% 3.0% 5.0% 5.0%

Group EBIT % 8.3% 7.5% 1.7% 0.8% 3.8% 6.4% 7.4%



8 December 2009 56

Figure 89: BMW Group balance sheet, 2006A-2012E

As at end-December (€mn) 2006 2007 2008 2009E 2010E 2011E 2012E

Industrial/Auto Assets:

Intangible assets 5,276 5,333 5,403 5,212 5,265 5,365 5,488

Property, plant and equipment 11,260 10,870 11,074 10,598 11,212 11,272 11,306

Leased products 254 254 268 268 268 268 268

Investments 448 6,184 2,775 2,775 2,775 2,775 2,775

Financial assets & other assets 2,128 1,506 3,728 3,728 3,728 3,728 3,728

Industrial fixed assets 19,366 24,147 23,248 22,581 23,249 23,407 23,565

Inventories 6,784 7,036 7,005 7,200 6,700 6,900 7,200

Trade receivables 2,214 2,070 2,438 2,300 2,100 2,200 2,300

Financial & other receivables 5,796 15,178 14,018 13,740 11,240 11,240 11,240

Marketable securities 2,348 2,734 1,401 1,401 1,401 1,401 1,401

Cash and cash equivalents 1,235 1,249 5,073 5,407 6,729 5,767 5,920

Industrial current assets 18,377 28,267 29,935 30,048 28,170 27,508 28,061

Industrial total assets 37,743 52,414 53,183 52,629 51,419 50,915 51,626

Financial services total assets 47,725 59,656 69,792 70,836 69,429 70,339 71,266

GROUP TOTAL ASSETS 79,057 88,997 101,086 103,183 99,470 99,994 101,758

Industrial non-current liabilities 11,797 10,986 13,861 12,861 12,861 12,861 12,861

Industrial current liabilities 10,631 19,845 16,841 21,374 21,045 21,134 20,886

Industrial total liabilities 22,428 30,831 30,702 34,235 33,906 33,995 33,747

Financial services total liabilities 42,760 55,517 66,040 65,489 64,680 65,203 65,737

GROUP TOTAL LIABILITIES 59,927 67,253 80,813 84,725 83,585 84,199 84,484

Industrial equity 15,315 21,583 22,481 18,394 17,513 16,919 17,880

Financial services equity 4,965 4,139 3,752 5,346 4,750 5,135 5,529

BMW shareholders’ equity 19,126 21,733 20,265 18,450 15,877 15,787 17,266

Minority interests 4 11 8 8 8 8 8

Group shareholders' equity (incl MI) 19,130 21,744 20,273 18,458 15,885 15,795 17,274

Industrial total liabilities & equity 37,743 52,414 53,183 52,629 51,419 50,915 51,626

Financial services total liabilities & equity 47,725 59,656 69,792 70,836 69,429 70,339 71,266

TOTAL GRP LIABILITIES & S'HOLDERS EQUITY 79,057 88,997 101,086 103,183 99,470 99,994 101,758

Balance sheet analysis & drivers:

Net industrial working capital 5,710 6,337 7,414 5,938 5,567 5,778 6,426

Working capital/sales 12% 12% 15% 14% 13% 12% 13%

Industrial net cash (debt) 5,385 7,052 9,046 9,880 11,202 10,240 10,393

Unfunded pension 'debt' (4,983) (4,602) (3,297) (3,900) (3,900) (3,900) (3,900)

Industrial net debt (cash) post pensions 402 2,450 5,749 5,980 7,302 6,340 6,493

Gearing (pre-pension) 35% 33% 40% 54% 64% 61% 58%



8 December 2009 57

Figure 90: BMW cash flow statement


Industrial net income 2,449 2,963 226 (422) 285 1,146 1,787

Industrial Depreciation & amortisation 3,665 3,568 3,567 3,660 3,621 4,638 4,864

Other (308) (78) (499) (1,000) 0 0 0

Change in inventories (703) (663) 9 (195) 500 (200) (300)

Change in receivables (98) 371 597 138 200 (100) (100)

Change in liabilities 368 85 571 1,533 (330) 90 (249)

Total movement in WC (433) (207) 1,177 1,476 370 (210) (649)

Industrial Cash inflow from operating activities 5,373 6,246 4,471 3,715 4,277 5,575 6,002

FS cash flow from operating activities 4,607 5,110 5,603 6,000 6,000 4,000 5,000

Group cash flow from operating activities 9,980 12,183 10,872 9,215 9,777 9,075 10,502

Industrial Capex (incl capitalised R&D) (4,241) (3,833) (3,937) (3,185) (3,259) (3,711) (3,891)

Net financial investments 52 (131) (317) 0 0 0 0

Net proceeds from leased products (28) (5) (20) 0 0 0 0

Net change in marketable securities (200) (130) (278) (2,500) 0 0 0

Industrial cash flow from investing (4,417) (4,099) (4,552) (5,685) (3,259) (3,711) (3,891)

FS cash flow from investing (9,253) (13,198) (14,218) (4,000) (5,000) (6,000) (6,000)

Group cash flow from investing (13,670) (17,248) (18,652) (9,685) (8,259) (9,711) (9,891)

Capital Increase (253) 0 (10) 0 0 0 0

Dividends Paid (419) (458) (694) (196) (196) (327) (457)

Change in Debt (525) (1,024) 4,649 3,000 0 0 0

Industrial cash flow from financing (1,197) (1,482) 3,945 2,804 (196) (327) (457)

FS cash flow from financing 4,520 8,340 9,890 (2,000) 0 0 0

Group cash flow from financing 3,323 6,168 12,904 804 (196) (327) (457)

Industrial change in cash (debt) (137) 650 3,824 834 822 1,537 1,654

FS change in net cash (debt) (148) 241 1,264 0 0 0 0

Group Change in net cash (debt) (285) 1,057 5,061 334 1,322 (963) 154

Cash flow Statement analysis & drivers:

Industrial FCF (company definition*) 956 2,147 (81) (1,970) 1,018 1,864 2,111

Industrial FCF (Barclays Capital definition**) 1,132 2,413 534 530 1,018 1,864 2,111

Group FCF 5,667 7,916 6,668 5,730 6,218 5,064 6,311

FCF per share 8.7 12.1 10.2 8.8 9.5 7.8 9.7

Group capex/Sales 8.8% 7.6% 7.9% 7.2% 7.4% 7.9% 8.0%

Industrial capex/sales 8.6% 7.0% 7.9% 7.5% 7.5% 8.0% 8.0%

Group capex + R&D/Sales 14.0% 12.8% 13.2% 12.4% 12.4% 12.9% 13.0%

Group capex/D&A 131.8% 115.9% 114.6% 87.0% 90.0% 80.0% 80.0%

Source: Company data, Barclays Capital * Industrial Cash from operations + Industrial cash from investing; **Industrial Cash from operations + Net Capex


8 December 2009 58

Figure 91: BMW revenue mix by division 2009E Figure 92: BMW revenue mix by division, 2000A-2015E

Financial Services

27%

Moto2%

Autos71%

0

10000

20000

30000

40000

50000

60000

70000

80000

2000 2002 2004 2006 2008 2010E 2012E 2014E

Automobiles Motorcycles Financial Services

Source: Barclays Capital Source: Company data, Barclays Capital

Figure 93: BMW unit sales by model, YTD 09A Figure 94: BMW EU sales mix 09E vs industry average (%)

1 Series21%

3 Series39%

X35%

Z3/Z42%

5 Series16%

X64%

6 Series1%

X58%

7 Series4%

0%

5%

10%

15%

20%

25%

30%

35%

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BMW Industry avg

Source: Company data Source: CSM, Barclays Capital

Figure 95: BMW EBIT mix by division, 2010E Figure 96: BMW EBIT margin by division, 2004A-2015E

Financial Services

EBIT36%

Moto EBIT5%

Auto EBIT59%

-2%

0%

2%

4%

6%

8%

10%

2004 2006 2008 2010E 2012E 2014E

Auto EBIT % Motorcycle EBIT %

FS EBIT % Group EBIT %

-2%

0%

2%

4%

6%

8%

10%

2004 2006 2008 2010E 2012E 2014E





8 December 2009 59

DAIMLER – MARKET OVER OPTIMISTIC ON COST-CUTTING POTENTIAL

We are initiating coverage of Daimler with a 3-Underweight rating and €32 price target. Given the pricing, demand, and currency pressures we expect to continue in the premium market, we favour companies that can deliver and retain near- and mid-term cost reductions ahead of market expectations. Our 3-Underweight rating is driven by our concern that the market has run ahead of itself on its expectations for the company’s cost-cutting potential. Whilst market estimates for German peer BMW look for only €1.4bn of YoY EBIT improvement in 2010E (despite new 5- and 7-series models, superior fuel efficiency credentials and higher level of modularity), market estimates for Daimler are expecting a much more aggressive €4bn EBIT delta. Of course, Daimler’s Truck division (historically 25% of group EBIT in ‘normal’ market conditions) is believed to be at rock bottom in 09E but even with our Daimler Truck division estimates in-line with consensus expectations for truck market peers, this provides only €2bn additional EBIT (and risky, as consensus on trucks may be too optimistic given the tepid recovery potential, at best, for the European truck market).

Daimler management has been vociferous on the company’s achievements regarding cost cutting in 2009, with gross savings of €3.5bn achieved YTD and the company announcing that it is on track to exceed its €4bn target for the full year. Yet it is difficult to reconcile these €3.5bn gross savings with the disclosures of net impact on EBIT. Although management has committed to an additional €4bn of savings for 2010E, we are concerned that the majority of these will likewise be absorbed be negative factors (price, FX and raw material costs), whereas we believe market assumptions are overestimating the retention potential. We believe that DAI is more exposed to pricing risks than BMW, having unfortunately launched its E-class six months too early into a falling luxury market. Based on our FX forecasts for USD and GBP exposure we believe that Mercedes faces significant currency exposure in 2010E, due to its lower degree of natural hedging than BMW. We also think that Mercedes’ youthful workforce (hence less scope to cut labour costs), its lack of modular-focused savings (relative to BMW and especially Audi/Porsche), and its belated efforts in the field of fuel economy provide less fat to trim in the next 12-18 months.

Valuation metrics further point us to prefer BMW (currently 18% 2010 EV/sales vs 44% at DAI, though admittedly DAI also incorporates high-rated trucks) and using a SotP methodology (for further detail see the valuation section), we reach a €32 price target, which leads us to initiate coverage of Daimler with a 3-Underweight rating.


Negatives:

Market over-confident of company’s potential for retaining further gross cost savings

Youthful workforce makes achievement of gross savings less likely

Daimler remains the OEM facing the greatest pressures from USD and GBP weakness

Pricing pressures to affect luxury end of the market and Mercedes worst affected because of ageing model line up in comparison to BMW’s new 5- and 7-series

Lower capacity utilisation rates and levels of modularity provide less potential for savings than at peer BMW

DAIGn.DE / DAI GY




Price (04-Dec-2009) €35.91



8 December 2009 60

Risks to our 3-Underweight rating:

A stronger-than-expected recovery in the truck sector

Exposure to faster growing market, such as China but also the early-recovering US market could provide additional upside to the share

Figure 97: Daimler – headline data and valuation multiples (at current share price), 2008-11E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 95,873 77,507 80,883 88,258 91,782

EBIT 2,730 (1,619) 1,453 3,690 4,502

EBIT margin (%) 2.8 -2.1 1.8 4.2 4.9

BC EPS € 1.41 (2.02) 0.61 2.20 2.75

Consensus EPS € 1.41 (1.79) 1.40 2.87 3.22

Industrial EV/sales (%) 44% 45% 44% 40% 38%

Industrial EV/EBITDA 4.1x 11.7x 5.4x 3.7x 3.5x

P/E ratio (%) 29.8x (16.6) 54.7x 15.2x 12.2x


Management urges caution as market runs ahead of itself With the market currently, we believe, looking out to 2010E earnings and beyond, management’s forecasts for “positive earnings from ongoing business” and “positive FCF” for 2009 have become less relevant. Instead, we feel the market is currently focused on Daimler’s cost-cutting potential. Big headlines flaunting the over-achievement of 2009’s €4bn cost-cutting target and aims to make 2009’s savings permanent and also to exceed those savings incrementally in 2010E have, we believe, driven Daimler’s relative price outperformance versus BMW in recent months (DAI +22% relative to DJ Euro STOXX -6 months, vs BMW +15%). And yet management has neither reconciled the gross savings achieved already with Daimler’s YoY EBIT delta, nor have they provided any specific detail on how a further €4bn in savings will be achieved in 2010E. Indeed, recent company statements have led us to believe that even management themselves believe that current analysts’ forecasts have run ahead of company guidance.

Figure 98: DAI has outperformed BMW by 12% since July 09

-4%-2%0%2%4%6%8%

10%12%14%16%18%

7/1/2009 8/1/2009 9/1/2009 10/1/2009 11/1/2009

DAI share price relative to BMW

Source: Datastream


8 December 2009 61

New E-class launched six months too early Unfortunately for Mercedes, 2009’s big model launch, the all new E-class, could not have come at a worse point in global auto markets. Whilst scrappage incentives at least boosted the lower end of the market, the higher-mix C and above segments were hit hard by the global recession. Though at 10M09 E-class sales were up 24,000 units YoY and to date in 2H09 comprised 22% of MBC group sales, (vs 25% in its last peak model year), the executive segment as a whole was down 50bp in Europe in 2009 and was likewise hit hard in the US. By contrast, we expect the segment share to recover again in 2010-11E just as the E-class laps its model launch anniversary and to top it off, its closest rival launches its all new 5-series.

Figure 99: C and above segments to experience most growth 2010-11E

-413

-540

-45

89

38

-4

-600 -500 -400 -300 -200 -100 0 100 200

A - Basic

B - Small

C - Lower Medium

D - Upper Medium

E - Executive

F - Luxury

Change in units 2009-11E (000)


After the launch of the E-class in 2009 (with the E-class SW in Q409 the final model in the range), DAI has passed its peak model cycle and will have to wait until C-class replacement in 2014 before it gets another high volume, strong mix launch. We therefore expect the new E-class will help boost Mercedes margins in 2H09E and into 1H10E but we expect the benefits to be short-lived as its rival BMW, with its new 5 and 7-series models and better fuel efficiency credentials, takes the prize for most youthful product line-up. Whilst exposure to the high-growth Chinese market should buffer weaker demand in Triad markets, we still believe that top-line market estimates for MBC are overly optimistic.

Figure 100: New E-class likely to aid 2H09 earnings but company losses model age battle with BMW by 2010E

Brand 2008 2009 2010 2011 2012

Mercedes CLC Q1 E-class Q1 E-coupe cab Q1 A-class Q1 M-class

SL Q2 E-Coupe Q2 SLS Q2 B-class Q3 B-class SUV

GLK SUV Q4 E-class SW Q4 CLS Q3 SLK Sub A-class

Smart ForFour?

Source: JD Powers, trade press and Barclays Capital


8 December 2009 62

Pricing pressures to hurt Mercedes as E-class ages

One of our biggest concerns for the European market in 2010E, and for Mercedes cars in particular, relates to pricing. Perhaps the most insidious unintended consequence of the scrappage programmes will be a potential breakdown in pricing discipline in key European markets, leading to more transparent pricing and a price-shopping consumer. We believe that European manufacturers will follow the US pattern of over-incentivising end-prices in an attempt to boost volumes. While scrappage programmes were aimed at the volume small car market, the programmes appear to have shifted price expectations amongst luxury buyers. In the most recent set of results presentations, as well as in our discussions with management, luxury makers reported that pricing in key markets was coming under pressure as consumers and dealers demanded rebates to match those offered under scrappage programmes to volume makers.

In Germany list prices are currently about 5.5% more than the average for the 16 euro denominated countries, which allows greater flexibility for manufacturer/dealer incentive packages – the flip side of which being greater opportunity for margin erosion. The German government’s €5bn scrappage incentive programme ran out of money in September, prompting carmakers to step up discounts yet further.



Avg incentive/car (€) 2,485 2,292 €2,528



Figure 101: Mercedes’ mix skewed to higher segments

Figure 102: E-class historically 25% of sales (but closer to 40% of MBC profits)

0%

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A/B-Class

C-Class

E-Class

S-ClassM/R/Gsmart

0

200

400

600

800

1,000

1,200

1,400

1996 1998 2000 2002 2004 2006 2008 2010

Source: JD Powers, Barclays Capital Source: Company data, Barclays Capital


8 December 2009 63

To date, we believe this pressure, both in Mercedes’ domestic market but also in the rest of Europe, has been buffered only partially by new model roll outs. We expect the full availability of new E-class to boost price and mix by €770mn in 2H09E (versus an estimated €2.7bn negative impact in 1H09 when Mercedes like all other OEMs was attempting to drive down overstockage via pricing promotions), but our estimates for 2010E assume a €300m negative EBIT impact from price and mix. This forecast is based on 200,000 new E-class sales in 2010 at an estimated €2,000 additional price/unit (a generous assumption since E-class renewal began in Q109 but allowing for easy YoY comparisons due to the effect of launching in a weak pricing year). For mix, we assume a €5,000 incremental contribution per unit for the model. However, this combined €575mn positive impact from new E-class is more than negated, we estimate, by the overall negative pricing environment which we expect to affect pricing on all other European and US vehicles by a negative €1,000/vehicle.

Figure 104: Despite positive mix effects of new E-class, negative pricing drives an overall €100mn negative price/mix impact for Mercedes

E-Class Other models Total MBC

Additional vehicles (units) 200,000

Additional price/vehicle (€) 2,000

EBIT price impact (€mn) 400 400

Negative price/vehicle (€) (1,000)

EBIT price impact (€mn) (880) (880)

Est. EBIT mix effect (€mn)* 175 175

Total Mercedes EBIT delta (€mn) (300)

Source: Barclays Capital; *assuming €5,000 EBIT contribution/vehicle for incremental E-class sales

Another knock-on effect of such pricing ill-discipline is likely to be that manufacturers are no longer in a position to significantly raise prices in countries affected by currency devaluations. This will have the greatest impact for Mercedes as it has the greatest exposure to sterling and US dollar denominated sales (see FX discussion below).

Less potential to trim costs than BMW

Over-achievement of cost savings in prior periods hampers 2010 delta Though we credit Mercedes with €600mn of further production & procurement savings in 2010E, we believe that its potential for deeper and more permanent savings is much less than at BMW. Rather unfairly, this is due to the fact that BMW has come later to the modularity game, leaving it more potential in future to improve productivity. Unfortunately for Mercedes, its hugely successful CORE restructuring programme which ended in 2007, saw a great deal of costs taken out of the production system before we even entered the market downturn, leaving them less room for flexibility when markets recover. Although there are still incremental savings to be made via increased commonality between models, we expect that a vast majority of these have already been achieved via 2007’s C-class roll-out and this year’s E-class, both of which have been produced based on the modular concept.

Additionally, Mercedes faces higher R&D costs in the years ahead as it lags behind its Munich-based peer in fuel efficient technologies. Whilst we believe that this risk is already fully understood by the market, we also believe the market is over-playing the future benefits of other cost saving efforts, the details of which have yet to be disclosed, and of which so far there has been little evidence of achievement at the net level in 2009.

Despite the positive price and mix effects of E-class and S-class renewals on 2010 EBIT, negative pricing for the overall market will

drive an expected €100mn price/mix headwind in the year


8 December 2009 64

Despite the efforts of the CORE restructuring programme, Daimler still has the greatest excess capacity among its premium peers in Europe – with the likely ability to manufacture 369,000 more vehicles in 2010E than the market will demand. In 2009E, this provided greater flexibility to use schemes such as kurstarbeit (or short-time work) in Germany, in order to cut labour costs to deal with the dramatic fall in production levels in the year but it has also left a great deal of under-absorption of fixed costs. With no major new models due to come to market in the next 12 months, over-capacity will, we believe, be a drag on earnings in 2010E.

Youthful workforce does not aid further productivity savings Mercedes has been grabbing the headlines recently with announcements on the potential for further headcount reductions. Our 2010E EBIT walkdown (see Figure 78) gives the company the benefit of €1.3bn in savings from personnel/SG&A in 2010E as kurtzarbeit continues until June 10E and we should see the full-year effects of the 6,000 workers who left the company in 2009, as well as the further redundancies the company has discussed. However, longer term, we believe that there is less flexibility in the workforce than at BMW due to its more youthful age. With c2% of all workers aged >50 years (vs. 20% at BMWs), natural attrition will not be such an easy lever for Mercedes going forward.

Figure 107: DAI average worker age vs. peer BMW (years)

Percent over 50 yrs (%) Average age (yrs)

Daimler hourly 2 40.8

Daimler salaried 2 41.6

BMW hourly 17 39.6

BMW salaried 25 42.4


Figure 105: DAI has greatest excess capacity of premium peers

Figure 106: Below average capacity utilisation at Mercedes

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8 December 2009 65

Size of impact from USD and GBP weakness likely to surprise the market The aggressive fiscal and monetary stimulus taken by the UK and US governments have led to a weakening of their currencies, creating further pressures (perhaps unintended) on importers into those markets. Over the last year, the pound has fallen 15% relative to the euro while the US dollar has slipped 12%.

As we argued in the front section of this report, we believe that the market is currently underestimating the full impact of this weakening in foreign exchange rates relative to the euro for the autos sector in 2010E. With 20%, or €18bn, of group revenues in North America in 2008, Daimler has one of the largest US dollar exposures of all European OEMs. The main transactional currency risk lies in the MBC car division, although Daimler trucks (and to a much lesser extent Van & Buses) also has a small degree of FX exposure.

Natural hedging provides shelter from USD but zero natural protection from GBP

In 2008, 250,000 MBC vehicles were sold in North America but only 153,000 vehicles (M-class, GL-class and R-class) were produced, leaving the company with net imports of 100,000 vehicles. Although this figure fell significantly in 2009, as US sales collapsed, we expect the total US SAAR to recover back to 12mn vehicles in 2010E, thus leaving MBC with 162,000 vehicles imported from euro-denominated countries, plus a further 260,000 engines. Although sourcing in USD in Mexico and also to a large degree in China helps to balance the gross currency exposure, we still expect a US$14bn net currency position in FY10E, or 40% natural hedging. Despite the company’s recent announcement that it will be shifting 20% of its C-class production to its US factory in Alabama starting in 2014 to help compensate for a weak dollar, we do not expect the benefits of this to be seen for at least another 4-5 years.

Figure 108: Mercedes estimated natural hedging protection for USD and GBP, 2010E

Units Sale value in US$mn

N Am sales 262,683 24,103

N Am production 100,800 6,400

Net vehicle imports 161,883 17,700

N Am engines imported 262,683 1,100

Gross currency position US$ 18,800

Est. emerging market sourcing in US$ 4,500

Net currency position, US$ 14,300

Natural hedging percentage 40%

GBP exposure – Mercedes & Smart cars Units Sales value in GBPmn

UK sales 79,100 3,010

UK production 0 0

Net vehicle imports 79,100 3,010

UK engine imports 79,100 240

Net currency position, GBP 3,250

Natural hedging percentage 0%


40% natural hedging from USD leaves MBC with a likely $14bn net currency position

(pre-financial hedges) in 2010E


8 December 2009 66

Unlike BMW, Mercedes’ UK exposure is not mitigated by any production facilities in the region. Zero percent natural hedging therefore leaves the company with £3bn net exposure to sterling FX rates in 2010E. Therefore our natural hedging assumptions for Mercedes -- 40% in the US and 0% in UK compare with a much greater 44% and 45% at BMW, due to BMW’s higher level of production in both the US and UK.

Despite financial hedging DAI’s EBIT FX impact likely €0.9bn in FY10E

Although at least 60% of 2010’s net currency position has already been financially hedged by the company, our calculations of Daimler’s EBIT exposure to the GBP and USD lead us to forecast a €900mn total FX headwind for Daimler in 2010E -- enough to wipe out 70% of the expected effects of personnel and SG&A based productivity savings in the year. Despite selling fewer cars than BMW in both the UK and US, Mercedes’ negative EBIT delta from FX is -€450mn higher than our estimate for BMW’s FX exposure in FY10E, due to Daimler’s lower degree of natural hedging in the regions.

Figure 109: DAI estimated USD and GBP exposure, 2008-12E (units as stated)

2008 2009E 2010E 2011E 2012E

North American volume (units) 282,000 228,420 262,680 275,820 286,850

Natural hedging volume in USD (%) 40% 44% 40% 41% 41%

Net currency position, N Am (USD mn) 14,400 13,400 14,300 16,100 29,200

Financial hedging volume (%) 90% 90% 60% 20% 0%

Spot rate 1.39 1.45 1.49 1.49 1.49

Estimated effective rate 1.37 1.35 1.42 1.48 1.49

USD Impact on EBIT (€mn) (680) 150 (540) (440) (110)

UK volume (units) 108,500 92,500 79,100 69,800 77,900

Natural hedging volume in GBP (%) 0% 0% 0% 0% 0%

Net currency position, (GBP mn) 2,680 3,480 3,250 2,890 3,200

Financial hedged volume (%) 95% 95% 60% 20% 0%

Spot rate 0.80 0.89 0.91 0.91 0.91

Effective rate 0.75 0.79 0.84 0.89 0.91

GBP impact on EBIT (€mn) (270) (200) (360) (210) (70)

TOTAL XR impact on EBIT (€mn) (950) (50) (900) (650) (180)


Note that our FX forecasts assume that spot rates remain at current spot levels (despite forward FX markets implying the probability of further weakening from both the USD and GBP). Any further 1cent weakness in the US rate would provide a further €40mn headwind for Daimler in 2010E and likewise a 1p weakening in the GBP rate would impact profits by €20mn.

With no production in the UK but an expected 79,000 vehicle sales in the region in 2010E, MBC has

a £3bn net currency position (pre-financial hedging) from UK

sterling

Mercedes’ 2010E EBIT impact from FX forecast to be €0.9bn--

every further 1cent weakening in USD rates, an additional €40mn and every 1p weakening in GBP

rates a further €20mn impact


8 December 2009 67

We believe that consensus numbers are currently not factoring in the severity of 2010’s FX headwinds for the auto industry as a whole. Whilst other manufacturers have significant exposure to either the USD or GBP, Daimler remains the most exposed to movements in FX rates due to its relatively low level of natural hedging versus the high proportion of sales in the US, in particular.

Figure 112: We forecast an EBIT delta of €1.0bn for MBC in 2010E, with €1.8bn cost savings

MBC cost walkdown (Delta) - €mn 2009E 2010E 2011E 2012E

Prior year EBIT 2117 (731) 309 849

Volume (1,680) 410 510 470

Price/Mix (2,000) (100) 430 290

Raw Materials & other input costs 200 (220) - -

Production & procurement - 600 300 -

Currency (50) (900) (700) (200)

Personnel/SG&A, R&D (50) 1,250 0

Other* 732 - - -

Total change in fixed costs (1,168) 630 30 (200)

Operating margin delta (2,848) 1,040 540 270

Current year EBIT (731) 309 849 1,119

EBIT margin (%) -1.8 0.7 1.9 2.4


Trucks at rock bottom but speed of recovery likely to lag cars With truck peers not currently rated by Barclays Capital, we base our Daimler truck forecasts on what we believe to be consensus estimates for the European, North American and Asian truck markets 2010-12E. Even presuming truck margins recover from 2009’s low of -5.3% to 6.5% by 2012E (just ahead of pre-crisis level averages for 2005-07 but behind 2007’s peak of 7.5%), only provides an extra €2bn EBIT to the group.

Figure 110: EURUSD forward rates remain close above $1.45

Figure 111: Forward rates imply GBP burden will intensify

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8 December 2009 68

We note that using market estimates is risky, as consensus on trucks may be overly optimistic given the tepid recovery potential, at best, for the European truck market. A youthful European truck fleet (German >16t trucks are just 3.5yrs old, according to KBA data), raises concerns about the speed of the cyclical recovery in the region and make it likely that the recovery will take much longer than for car markets. Whilst GDP growth in 2010 in the NAFTA region should trigger higher transportation volumes, new EPA 10 regulations are likely to dampen the chances of a V-shaped recovery and although the average age of the fleet is much older than in Europe, there are currently a large proportion of parked trucks which will be utilised ahead of new purchases. Daimler management have also urged caution against over-optimism on the truck outlook, with Q409E and early 2010E likely characterised by deterioration in regional mix, weaker pricing and restructuring costs.

Figure 113: Giving company benefit of doubt by assuming consensus truck estimates

Trucks 2008A 2009E 2010E 2011E 2012E

Unit Sales (units) 472,074 256,925 283,000 328,000 348,000

Unit sales growth (%) 1 -46 10 16 6

Implied Rev/unit (€000s) 61 75 70 70 70

Revenue growth (%) 0.4 -36.7 9.5 15.9 6.1

EBIT margin (%) 5.6 -5.3 2.9 6.0 6.5

Incremental margin (%) -485 24.5 88.5 25.7 14.3


Other businesses to recover, albeit at a slow pace

We expect the European LCV market to grow 130bp in share by 2012E from 2009’s low level when the segment accounted for just 9.2% of sales in the W EU market. Although Daimler is not a market leader in this segment, we expect it to benefit from the recovery in the overall market and to return to 6-7% margins by 2012E.

Figure 114: LCV segment market share 2006-12E

LCV Segment 2006 2007 2008 2009 2010 2011 2012

LCV units sales (mn) 1.73 1.82 1.71 1.35 1.38 1.53 1.60

Van share of EU market (%) 10.3 10.8 11.1 9.2 10.5 11.0 10.5

DAI share of Van market (%) 9.0 9.7 9.9 8.8 9.2 9.4 9.4



8 December 2009 69

Likewise, we expect ongoing strong city bus development to boost revenues and help EBIT margins recover to 6.5% by 2012E, thought still behind 2008’s level of 8.4%.

Figure 117: Vans & Buses segment expected to return to close to pre-crisis levels by 2012E

2008A 2009E 2010E 2011E 2012E

Vans

Unit sales (units) 287,198 153,000 191,000 206,000 208,000

Implied Rev/unit (€ 000) 33 40 34 34 34

Revenue growth (%) 1.5 -35.4 6.1 7.9 1.0

EBIT margin (%) 8.6 -1.6 2.0 6.0 7.0

Buses

Unit sales (units) 40,591 32,500 34,000 39,000 39,600

Implied Rev/unit (€ 000) 118 128 125 125 125

Revenue growth (%) 10.5 -13.5 2.2 14.7 1.5

EBIT margin (%) 8.4 4.5 5.0 6.0 6.5


Financial Services returns muted Although Daimler’s financial services business provided a stable profit-stream historically, the credit crisis and resultant liquidity squeeze and US leasing issues have drastically reduced the returns from this business. Although liquidity has now returned to the market and lower interest rates will aid the spread on new customer contracts, we believe that higher cost of risk levels will continue for at least the next 12 months and combine with the lower profit contracts (struck during the crisis) which will take three years to come through the system, thus hurting RoE for some time to come.

Figure 115: LCV market share in Europe 2010E

Figure 116: LCV market set to recover 180bp from 2009’s low

PSA25%

Renault-Nissan17%

VW Group15%

Fiat 14%

Ford 11%

Daimler9%

Opel 6%

Other3%

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Source: CSM and Barclays Capital Source: CSM and Barclays Capital


8 December 2009 70

Balance sheet remains attractive From a balance sheet perspective Daimler remains an attractive asset after generating €2.3bn of FCF in 9M09 and thus increasing its net liquidity to €6.7bn (versus €3.1bn in Dec 08). Much of this increase was aided by a reduction in inventories (which boosted working capital in the cash flow by €3.5bn at 9M09), whilst we think that rising production rates will provide a drag on cash flow in coming months as both inventory and supplier payable levels build again – we estimate a €1bn outflow from industrial FCF in 2010E – we are confident that Daimler’s strong history of cash management and above average credit rating, will help maintain a relatively stable level of cash on the balance sheet. Note that our autos credit analysts, Darren Hook and Rob Perry, have a neutral CDS view and Marketweight cash rating for Daimler and believe that current debt ratings (A3 Neg/BBB+/BBB+ Neg) are probably the lows for the foreseeable future with expected earnings improvement likely to reduce the risk of a downgrade to mid BBB.

Figure 120: Solid balance sheet and cash generation potential

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Figure 118: DAI’s FS portfolio to grow as credit supply returns

Figure 119: Cost of risk to peak in 09, ROA to slowly recover

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8 December 2009 71

Rating We are initiating coverage of Daimler with a 3-Underweight rating and €32 price target due to our expectations that the market has run ahead of itself on its forecasts for Daimler’s cost saving potential. We expect pricing, demand, and currency pressures to continue in the premium market and therefore favour companies that can deliver and retain near- and mid-term cost reductions ahead of market expectations.

Valuation methodology We value Daimler using a SotP methodology but we acknowledge that this assumes the market gives full credit to each constituent part of the company. In reality we have seen that Daimler has tended to trade much closer to BMW multiples, despite its supposedly higher-rated truck division historically comprising 25% of earnings. We therefore cross-check our valuation against historical and peer average EV/sales multiples and use a weighted average of the both methodologies to derive our price target.

Figure 123: Over-optimistic consensus estimates


Revenue (€mn) 80,883 82,684 -2.2%

EBIT (€mn) 1,453 2,638 -44.9%

EPS (€) 0.61 1.40 -56.2%


SotP

Using a sum-of-the-parts valuation we arrive at a €33 price for Daimler, implying 7% downside to its current market price. We base our calculation on a blended average of peer EV/sales and PE multiples for the core Autos business, peer EV/sales and EV/EBIT multiples for Daimler Trucks and bring in Finance companies and Vans & Buses divisions at historical average multiples. We also apply a 5% discount to the SotP valuation to take account of the historical holding discount for the trucks business.

We believe the market is overly optimistic on DAI’s potential to

deliver and retain future cost savings

Figure 121: After months of downgrades, 10-11E EPS estimates have recently been rising but are too high

Figure 122: Analyst recommendations have recently been growing more positive on DAI – we believe its too early

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8 December 2009 72

Figure 124: Daimler SotP implies downside to current share price

Sum-of-parts valuation, ex Chrysler €m € per shareREMARKS

Mercedes-Benz Cars 11,800 12 Average of: 39% 2010E EV/MBC Sales / 11x 2011E PE (in-line with BMW)

Daimler Trucks 11,400 12 Average of: 60% 11E EV/sales / 8x 11E EBIT (in line with truck peer multiples)

Van & Bus 4,400 5 Average of: 30% 11E EV/sales; 11x 11E PE

Chrysler 0 0

EADS 2,115 2 has 22.5% equity interest, incl 7.5% options (to convert on or after 1 July 2010)

SotP Industrial business 29,715 31

Financial Services 3,360 4 at 0.8x equity value

EV Operating business 33,075 35

Industrial net cash/(debt) 5,450 6 FY10E Net Industrial Cash

Group pension (3,570) (4) Under-funded pension status, 2010E (assuming 30% tax shield)

Healthcare liabilities (594) (1) Healthcare in North America (assuming 30% tax shield)

Minorities (1,508) (2)

Total EV 33,297 35

EV with holding discount 31,632 33 5% discount


EV/sales

Daimler has traded at a five-year historical median of 42% industrial EV/sales although during that period has ranged from a low of 13% in 2003 (incl Chrysler) to a high of 57% in 2007. On the same time frame, BMW has traded at a median average EV/sales of 39% and has ranged from 20% to 59%. Applying Daimler’s own historical average multiple would imply a price of €31.

Figure 125: At current price DAI is overvalued on EV/sales

Figure 126: DAI currently trades more richly than BMW

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8 December 2009 73

A weighted average of both these valuation metrics leads us to set a €32 price target for the share.

Figure 127: Daimler key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E


Industrial EV/sales (%) 41 57 44 45 44 40 38

Industrial EV/EBITDA 2.8x 4.3x 4.1x 11.7x 5.4x 3.7x 3.5x

Industrial EV/EBIT 7.1x 7.3x 18.4x (28.2) 29.6x 10.6x 8.7x

P/E 11.8x 16.5x 29.8x (16.6) 54.7x 15.2x 12.2x

FCF Yield (%) 29.1 16.3 -6.8 8.2 -3.0 0.0 3.3

Price/Sales (%) 48 72 46 52 49 45 43

Price/Book 1.2x 1.7x 1.2x 1.2x 1.1x 1.1x 1.1x

Dividend yield (%) 3.5 3.2 1.4 0.0 0.7 2.7 4.2

Valuation multiples at €32 price target



Industrial EV/EBIT 7.1x 7.3x 18.4x (25.7) 27.1x 9.7x 8.0x

P/E 11.8x 16.5x 29.8x (15.3) 50.6x 14.1x 11.3x

FCF yield (%) 29.1 16.3 -6.8 8.9 -3.2 0.0 3.6

Price/sales (%) 48 72 46 48 46 41 40

Price/book 1.2x 1.7x 1.2x 1.1x 1.1x 1.0x 1.0x

Dividend yield (%) 3.5 3.2 1.4 0.0 0.8 2.9 4.5



External risk – macroeconomic factors outside the control of the company, leading to an even stronger demand and pricing environment than we currently assume, could mean that the company exceeds our forecasts

Were truck markets to improve faster than consensus (and our) estimates, this would provide upside to the current share price

Currency risk – if USD or GBP rates were to improve significantly against the euro, this would ease the FX burden for Mercedes’ earnings forecasts.

Credit Perspective Barclays Capital credit analysts, Rob Perry and Darren Hook, rate Daimler Market Weight. They view Daimler as a high BBB credit given their expectations for credit metric recovery through 2010, with Daimler returning to revenue growth, supported by the new E-class as well as further cost cutting progress. The believe that the recovery in trucks, however, is likely to lag that of premium autos and management is likely to take a cautious approach to increasing inventory levels.


8 December 2009 74

Figure 128: Daimler Group income statement, 2006A-2012E

December year end (€mn) 2006 2007 2008 2009E 2010E 2011E 2012E

Net revenues 99,222 99,399 95,873 77,507 80,883 88,258 91,782

Cost of sales (78,782) (75,404) (74,314) (63,975) (64,453) (69,118) (71,619)

Gross profit 20,440 23,995 21,559 13,531 16,430 19,139 20,164

SG&A (13,024) (12,979) (13,328) (10,751) (10,462) (11,089) (11,594)

Research & development (3,018) (3,158) (3,055) (3,092) (3,476) (3,680) (3,598)

Other op costs, share of associates & financial income 594 852 (2,446) (1,307) (1,040) (681) (470)

Reported operating income 4,992 8,710 2,730 (1,619) 1,453 3,690 4,502

Memo: reported EBIT margin (% of sales) 5.0% 8.8% 2.8% -2.1% 1.8% 4.2% 4.9%

Non-recurring income and (expenses) (1,065) 981 (3,481) (660) 0 0 0

Memo: clean EBIT 6,057 7,729 6,211 (959) 1,453 3,690 4,502

Memo: clean EBIT margin (% of sales) 6.1% 7.8% 6.5% -1.2% 1.8% 4.2% 4.9%

Financial income/expense & other (90) 471 65 (800) (450) (350) (350)

Pre-tax income 4,902 9,181 2,795 (2,419) 1,003 3,340 4,152

Income tax (1,736) (4,326) (1,091) 415 (309) (1,022) (1,272)

Memo: tax rate 35% 47% 39% 17% 31% 31% 31%

Minorities/associates (39) (6) (66) (66) (66) (66) (66)

Net profit from continuing ops 3,127 4,849 1,638 (2,070) 627 2,252 2,814

Net income from discontinued ops 617 (870) (290) 0 0 0 0

Group Interest 3,744 3,979 1,348 (2,070) 627 2,252 2,814

EPS - basic 3.66 3.83 1.41 (2.02) 0.61 2.20 2.75

DPS 1.50 2.00 0.60 0.00 0.25 0.90 1.41

No shares (average) 1022.1 1037.8 957.7 1,023.8 1,023.8 1,023.8 1,023.8

Daimler Segmental Revenue:

MBC Cars 51,410 52,430 47,772 40,417 41,958 44,821 46,571

Trucks (CVs before 05) 31,789 28,466 28,572 18,087 19,810 22,960 24,360

Van & Bus (excl Chrysler & EADS post-2007) 13,151 14,123 14,970 10,280 10,744 11,879 12,022

Industrial revenues 91,948 90,688 86,591 65,785 69,512 76,660 79,953

Financial Services 8,106 8,711 9,282 11,722 11,370 11,598 11,830

Total Group revenues 100,054 99,399 95,873 77,507 80,883 88,258 91,782

Daimler segmental clean EBIT:

MBC Cars 3231 4835 2498 -731 309 949 1019

Trucks (CVs before 05) 2133 1957 1811 -599 566 1375 1574

Van, Bus, Other (from 05) 313 801 1410 89 342 713 817

Chrysler Group -468 -377 -1390 0 0 0 0

Industrial Clean EBIT 5,250 7,099 5,534 (1,040) 1,036 2,912 3,518

Financial Services 807 630 677 81 417 778 984

Total Group clean EBIT 6,057 7,729 6,211 (959) 1,453 3,690 4,502

Daimler Segmental Reported EBIT Margin %

MBC EBIT % 3.5% 9.1% 4.4% -1.8% 0.7% 2.1% 2.2%

Trucks EBIT % 5.8% 7.5% 5.6% -5.3% 2.9% 6.0% 6.5%

Mercedes-Benz Vans 8.6% -1.6% 2.0% 6.0% 7.0%

Daimler Buses 8.4% 4.5% 5.0% 6.0% 6.5%

VBO EBIT % 10.1% 13.8% -8.3% 0.9% 3.2% 6.0% 6.8%

Industrial EBIT % 4.6% 8.9% 2.4% -2.6% 1.5% 3.8% 4.4%

Financial Services EBIT % 10.0% 7.2% 7.3% 0.7% 3.7% 6.7% 8.3%

Total Group EBIT % 5.0% 8.8% 2.8% -2.1% 1.8% 4.2% 4.9%



8 December 2009 75

Figure 129: Daimler Industrial and Group balance sheet, 2006A-2012E


Intangibles 7,486 5,128 5,964 6,612 7,107 7,535 7,956

Property, Plant and Equipment 32,603 14,600 16,022 15,873 15,596 15,513 15,985

Operating Leases 10,383 8,186 7,185 7,200 7,200 7,200 7,200

Investments in Associates/non-consolidated co.s 4,824 4,845 4,258 4,258 4,258 4,258 4,258

Other non current financial assets/securities 5,044 3,928 2,758 2,758 2758 2758 2758

Deferred Tax & Other 7,383 1,952 2,998 2998 2998 2998 2998

Total Industrial Fixed Assets 67,723 38,639 39,185 39,699 39,918 40,262 41,155

Fixed Assets Financial Services 69,480 35,335 37,645 35,400 34,300 35,000 35,700

Total Group Fixed Assets 137,203 73,974 76,830 75,099 74,218 75,262 76,855

Inventories 17,736 13,604 16,244 13,493 13,369 13,746 13,493

Accounts receivable 7,423 6,135 6,793 5,046 5,523 5,881 6,133

Cash 6,060 14,894 4,664 8,025 7,009 6,763 6,992

Other current assets 485 (1,102) (2,375) 0 0 0 0

Total Industrial Current Assets 31,704 33,531 25,326 26,565 25,901 26,390 26,618

Current Assets Financial Services 48,727 26,667 30,063 29,500 29,200 30,100 31,000

Total Group Current Assets 80,431 61,120 55,389 56,065 55,101 56,490 57,618

Total Industrial Assets 99,427 73,092 64,511 66,264 65,819 66,652 67,773

Total Financial Services Assets 118,207 62,002 67,708 64,900 63,500 65,100 66,700

TOTAL GROUP ASSETS 217,634 135,094 132,219 131,164 129,319 131,752 134,473

Total Industrial Non-current Liabilities 33,060 24,299 20,817 25,468 24,468 24,468 24,468

Non-current Liabilities Financial Services 57,392 23,699 26,496 24,900 24,200 24,700 25,200

Total Group Non-Current Liabilities 90,452 47,998 47,313 50,368 48,668 49,168 49,668

Total Industrial Current Liabilities 37,842 14,927 15,602 15,802 15,249 15,099 15,412

Current Liabilities Financial Services 51,994 33,913 36,580 35,800 35,400 36,500 37,600

Total Group Current Liabilities 89,836 48,866 52,182 51,602 50,649 51,599 53,012

Total Industrial Liabilities 70,902 39,252 36,419 41,270 39,717 39,567 39,880

Total Financial Services Liabilities 109,386 57,612 63,076 60,700 59,600 61,200 62,800

TOTAL GROUP LIABILITIES 180,288 96,864 99,495 101,970 99,317 100,767 102,680

Industrial Equity 28,104 32,328 26,584 23,486 24,594 25,577 26,385

Financial Services Equity 8,821 4,390 4,632 4,200 3,900 3,900 3,900

DAI Shareholders' Equity 36,925 36,718 31,216 27,686 28,494 29,477 30,285

Minority Interests 421 1,512 1,508 1,508 1,508 1,508 1,508

Group Shareholders' Equity (incl MI) 37,346 38,230 32,724 29,194 30,002 30,985 31,793

Balance Sheet analysis & drivers: Net Working Capital 11,681 13,009 16,769 12,011 12,950 13,967 13,723

Working capital / Sales 13% 14% 19% 18% 19% 18% 17%

Net Industrial Cash (Debt) 9,861 12,612 3,106 6,470 5,450 5,200 5,430

Funded/(Unfunded) pension obligations (2,290) (1,912) (4,934) (5,100) (5,100) (5,100) (5,100)

Healthcare obligations/other post-employment benefits (14,102) (734) (848) (848) (848) (848) (848)

Industrial Net Cash (Debt) after Pensions (6,531) 9,966 (2,676) 522 (498) (748) (518)

Gearing (pre-pension) -35% -39% -12% -28% -22% -20% -21%



8 December 2009 76

Figure 130: Daimler Industrial and Group cash flow statement


Net Income 2,753 2,611 957 (2,125) 410 1,793 2,218

Depreciation and amortisation 7,173 4,220 3,123 3,472 4,173 4,600 4,267

Deferred tax (464) 3,121 653 653 0 0 0

(Gains) losses on disposals (545) (1,306) (712) 0 0 0 0

Chg in inventories 224 (1,621) (2,628) 2,751 124 (377) 253

Chg in trade receivables (118) 198 (517) 1,747 (476) (358) (253)

Change in trade payables 122 246 (644) 261 (587) (282) 243

Other chg in WC (344) (175) (984)

Change in Working Capital (116) (1,352) (4,773) 4,758 234 (453) (243)

Share in equity co's (net of dividends) (2,344) (1,706) (1,113) 0 0 0 0

INDUSTRIAL OPERATING CASH FLOW 6,457 5,588 (1,865) 6,758 3,644 5,377 6,728

Capital expenditure, net (5,162) (2,943) (2,207) (2,500) (3,130) (3,680) (3,840)

Additions to intangible assets (1,301) (1,327) (1,523) (1,447) (1,529) (1,687) (1,759)

Acquisitions less disposals of businesses 1,115 3,643 (513) -150 0 0 0

Changes in wholesale & retail receivables 1,466 1,558 3,644 0 0 0 0

Investment in shares (1,395) 4,528 112 (3,500) 0 0 0

Other 43 23,813 (1,015) 0 0 0 0

INDUSTRIAL CASH FLOW FROM INVESTING (5,234) 29,272 (1,502) (7,597) (4,659) (5,367) (5,599)

Debt issued/(redeemed) (1,215) (21,615) (647) 3,000 0 0 0

Dividends paid (722) (1,179) (1,861) (600) 0 (257) (900)

Equity issued/(redeemed) 306 1,440 (2) 1,800 0 0 0

Shares repurchased (29) (3,510) (4,218) 0 0 0 0

INDUSTRIAL CASH FLOW FROM FINANCING (1,660) (24,864) (6,728) 4,200 0 (257) (900)

Other / FX (432) (1,162) (135)

NET CHANGE IN INDUSTRIAL CASH (869) 8,834 (10,230) 3,361 (1,016) (246) 229

Operating cash from Finance Co's 7,880 7,500 5,070 0 0 0 0

Investing cash from Finance Co's (10,623) (8,735) (7,301) 0 0 0 0

Financing cash from Finance Co's 4,056 (340) 3,813 0 0 0 0

Other/FX from Finance Co's (98) (37) (71) 0 0 0

NET CHANGE IN GROUP CASH 346 7,222 (8,719) 3,361 (1,016) (246) 229

DAI cash flow analysis & drivers Industrial FCF (6) 1,318 (5,595) 2,811 (1,016) 10 1,129

Group FCF 12,842 10,632 (2,734) 2,811 (1,016) 10 1,129

Industrial Capex / Sales, % 5.6% 3.2% 2.5% 3.8% 4.5% 4.8% 4.8%

Industrial additions to intangibles/ Sales % 1.4% 1.5% 1.8% 2.2% 2.2% 2.2% 2.2%

Capex + R&D as %age of Sales 8.9% 6.7% 6.1% 8.5% 9.5% 9.6% 9.3%

Industrial Capex/Depreciation & Amortisation 72.0% 69.7% 70.7% 72.0% 75.0% 80.0% 90.0%



8 December 2009 77

Figure 131: Mercedes units by model, YTD 09 Figure 132: Daimler revenue by geography, YTD 09

A/B-Class20%

C-Class35%

E-Class14%

S-Class7%

M/R/G13%

smart11%

Germany23%

Other W EU Markets

25%USA19%

Asia14%

Other Markets

19%

Source: Company data Source: Company data

Figure 133: Daimler revenues by division, 04A-12E (€mn) Figure 134: Daimler Clean EBIT by division, 04-12E (€mn)

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Figure 135: Daimler EBIT Margin by division, 04-12E %) Figure 136: DAI Industrial Net Cash and Industrial FCF (€mn)

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8 December 2009 78

FIAT – EXCESS CAPACITY AND LOWER CHRYSLER TURNAROUND ENTHUSIASM DRIVE 3-UNDERWEIGHT RATING

We are initiating coverage of Fiat with a 3-Underweight rating and a €8 price target. While Fiat has rallied recently on hopes for Chrysler and press speculation of an Fiat Group Automotive (FGA) spin-off, we believe that while Chrysler is likely to survive through 2011, even a strong turnaround (albeit below management projections) would be worth only €1.50 per Fiat share by 2012. Moreover, by Fiat’s own admission, the prospects for a spin-off of FGA, which would in our view unlock the value of CNH and Iveco, are remote in 2010. As a result, investors will likely refocus on the core automotive business, which faces a difficult year as scrappage programmes fade away across Europe. As the programmes fade, Fiat, which benefited significantly from the shift to A and B vehicle segments, will be hit hard as volumes fall and price competition sharpens. The fall in volume will once again reveal the excess capacity in Italy, leading to negative headlines and difficult negotiations as Fiat navigates the delicate task of closing Italian capacity. We are therefore initiating coverage of Fiat with a 3-Underweight rating and a €8 price target, implying 24% potential downside from current levels.

We value the Fiat share based on an average of EV/sales and EV/EBTIDA at historical and peer average multiples, which lead us to our €8 price target (please see the valuation section for further details).


Negatives:

Heavy reliance on A and B sectors leaves Fiat exposed to a decline in post-scrappage volume and price wars in 2011

While offering potential longer-term potential, CNH and Iveco offer only a modest offset in 2010 and 2011

Chrysler turnaround enthusiasm is getting ahead of potential turnaround progress; 2010 and 2011 are likely to be marked by survival albeit through heavy incentives and fleet sales

Risks to our 3-Underweight view:

Extension and/or expansion of Italian scrappage schemes

More rapid rebound in truck and/or agricultural equipment

More rapid turnaround at Chrysler

FIA.MI / F IM



Price Target €8

Price (4-Dec-2009) €10.56



8 December 2009 79

Figure 137: Fiat – headline data and valuation multiples (at current share price), 2008-2011E

(€mn) 2008A 2009E 2010E 2011E 2012E

Industrial Sales 58,309 46,793 46,755 48,565 54,242

Industrial EBIT 3,362 896 477 1,019 1,924

Ind EBIT margin (%) 5.8 1.9 1.0 2.1 3.5

BC EPS € 1.29 0.09 0.05 0.36 1.04

Consensus EPS € -- -0.16 0.35 0.82 1.26

Adj Ind EV/sales (%) 31 36 35 33 25

Adj Ind EV/EBITDA 3.3x 4.7x 5.0x 4.3x 3.0x

P/E ratio (%) 8.8x 109.6x 205.6x 29.0x 10.0x


Unintended consequences of scrappage wind-down to hit Fiat hard Fiat’s mix – even before the scrappage boost of 2009 – had been tilted toward A and B segment vehicles. The various scrappage programmes, in particular the Italian programme, further boosted Fiat’s A and B reliance. While Fiat may indeed have the right long-term strategy with downsized vehicles and small, fuel efficient powertrains, it nevertheless will likely be hit in 2010 by the fallout from the end of the scrappage programmes in terms of volume, capacity and pricing.

Figure 138: Fiat’s current European sales mix significantly skewed to A&B segments

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Volume down as boost to A and B segment fades In 2009, Fiat is likely to have maintained sales volumes of 1.2mn in Western Europe, a YoY increase of only 4% vs. industry decline of 3.4%. As a result, Fiat’s overall share of WE increased 60bp to 8.9%. In Italy, sales fell even less, with YTD Fiat selling 602k units in 2009 vs. 604k in 2008.

However, much of this relative success appears due to the artificial mix shift engendered by scrappage programmes. In Italy, which is historically a smaller car market, A and B segments increased by 600bp, from 57% share to 63%. The shift in segment share across Europe can more than be accounted for by the scrappage programmes in the top five countries – for example, the German programme alone contributed 4.2 share points in 2009 to the overall European increase in volume B segment share vs. 2008.


8 December 2009 80

Figure 139: Scrappage programmes account largely for mix shift to A&B segments in 2009E

A segment B segment C segment

2008 segment market share 10.5% 29.5% 31.4% YoY chg by country: France 0.9% 0.5% 0.0% Germany 1.7% 4.2% 1.6% Italy 0.4% 0.2% -0.2% Spain -0.1% -0.4% -0.8% UK 0.3% -0.2% -1.0% Other 0.3% -0.8% -2.5% Memo: total change 3.2% 3.7% -1.8% 2009 segment market share 13.7% 33.1% 29.6%


Fiat was one of the key beneficiaries of the scrappage boost. In Italy, the scrappage programme was distinctly aimed at Fiat’s sweet spot in A and B segments. Italy restricted its trade-ins of ten-year-old and older cars, with a €1,500 car incentive to those new vehicles that met Euro 4 + emission standards and emitted a maximum 130 g/km (diesel) or 140 g/km (other fuels) of CO2, with an additional €1,500 – 3000 for CNG or other alternative fuels (a Fiat sub-specialty). The Italian scheme thus covered all of the Fiat 500s, and most models of Fiat Bravo, while at the same time excluding many variants of, for example, the VW Polo and Golf. (By contrast the German programme simply required compliance with Euro 4 emissions while France provides rebates for new vehicles for up to 160 g/km, enough to accommodate many versions of the Mégane). In the other countries, Fiat benefitted from the general tendency of scrappage buyers to choose A and B segment vehicles, although its share of those segments slipped somewhat as other automakers rushed to fill demand.

As a result, Fiat’s share of the Western European market, which rose from 8.3% in 2008 to 8.9% in 2009, was boosted by sales from the scrappage schemes. Overall, Fiat gained about 74k units of volume in the A and B segments, of which 150,000 units were from the overall increase of those segments in the European market, offset by some loss of Fiat share in these segments:

Figure 140: Fiat volume segment in Western Europe source of change 2008 vs. 2009

Fiat’s 2008 sales (volume market) 1,289,482

Sources of chg:

Total A/B segment chg YoY 74,892

Segment share 149,669

Fiat share in segment -74,777

Total C/D/E segment chg YoY -50,484

Segment share -24,504

Fiat share in segment -25,980

Total Van and other segment chg YoY -38,559

Segment share -49,593

Fiat share in segment 11,034

Fiat 2009 sales (volume market) 1,275,331

Source: JD Powers Forecasting, Barclays Capital


8 December 2009 81

In 2010, even with some trailing scrappage programme extensions, we expect the distortion of the A and B segment share to fall, with combined share of the volume the W European market falling 400bp - from 47% in FY09 to 43% in 2010E, meaning that total sales in the volume market would fall by 1.1mn cars in Western Europe, to a total of 4.6mn. In this context, although we would expect Fiat to revert closer to its 2008 share in the A&B segment this would still cause a drop of 190,000 vehicles for the manufacturer. Likewise, with only modest economic growth, we do not expect a significant rebound in the LCV market, which we see growing at 3% across Europe in 2010E.


8 December 2009 82

Exposing excess capacity and weak fixed cost absorption The scrappage programmes in Italy and beyond have helped to support utilisation at key Fiat factories in Italy. In mid-year, Fiat noted that the several plants had been boosted by scrappage incentives:

The Melfi plant (site of a bitter labour action in 2004) did not need to use temporary layoffs in March, April and May due to production volumes for Grande Punto (especially the LPG and CNG versions that received extra incentives), and scheduled weekend overtime.

The Mirafiori plant had good volumes for the Punto Classic, Musa, Idea (again, the incentivised CNG and LPG versions) and Alfa Mito, with reduced recourse to temporary layoffs (from April, more than halved vs. January) and limited weekend overtime.

Even the slated-to-close Termini Imerese plant enjoyed decent volume in the Ypsilon, (in particular LPG version) with reduced recourse to temporary layoffs in March, April and May

Cassino had some boost from LPG version of Bravo

With the fall in sales, we expect Western Europe production to decline from the pace of 8.6mn units in 2H09 to 8.0mn units in 1H10E. As a result, several Fiat factories that had enjoyed strong utilisation due to A and B segment build will see weaker capacity utilisation, joining the current underutilised factories that make larger cars.

Overall in Europe, Fiat had almost 500,000 units of excess capacity in 2008, but was able to reduce to 280,000 units in 2009, largely by stepping down straight-time capacity in Serbia. In Italy, straight time capacity was trimmed to 970,000 units in 2009, down from 1.2mn units in 2008, allowing for ‘only’ 280,000 units of excess capacity – at the same time, Poland ran at 108% to meet Fiat 500 demand. Excess capacity is likely to continue in Italy for the foreseeable future. Fiat has recently underscored in its annual meeting with its ‘social partners’ its plans to discontinue automobile production at the Termini Imerese plant in Sicily in 2011, perhaps converting to support agricultural equipment. Fiat will still suffer excess capacity in Italy of about 200,000 in 2011, or about the equivalent of 1 to 2 plants.

Outside of Italy, capacity utilisation is strong in Brazil, albeit weaker in Poland and Serbia where Fiat is adding capacity.

Figure 141: Fiat European capacity by country (units)

Figure 142: Fiat European capacity utilisation by country %

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8 December 2009 83

As CEO Marchionne turns his attention to a revised plan for Fiat Europe in 1Q10, we would expect management to begin to highlight the capacity issues and need for an industrial solution – a slow and difficult challenge in the context of Italian labour relations. Thus, we remain cautious near-term, especially as in the process of making the case for capacity reductions or increased flexibility, may lead management to take a more cautious tone around the prospects for the core European business. Longer term, the new plan will likely be a positive assuming it addresses some of the core overcapacity issues.

A further hit from likely weak A and B pricing in 2010 With its disproportionate focus on A and B segments, Fiat is particularly vulnerable to a post-scrappage price cutting pandemic. Consumers for A and B cars – even acknowledging that some were first-time new car buyers – have become accustomed to €1,500-2,500 of government incentives, often with matching manufacturer incentives on top. And manufacturers have become accustomed to the lift to capacity utilisation provided by scrappage programmes.

Already in Germany, the country with the most aggressive scrappage scheme in 2009, OEMs have significantly added to the government’s €2,500/vehicle incentive with their own generous discounts:



Avg OEM incentive/car (€) 2,485 2,292 2,528



Progress in modularity unlikely to provide offset in near-term While Fiat has been a strong champion of modular architectures, we do not see significant ability for these programmes to offset the pricing and capacity issues over the next few years for three reasons. First, Fiat (unlike Renault) is already well advanced in its move to modularity, and likely has seen benefits already reflected in its 2008 and 2009 earnings. Second, Fiat lacks the global scale in its key platforms – especially C and D – relative to other auto makers and across platforms. Third, the benefits from Chrysler are likely only post-2012 as Chrysler reengineers its product lines (and as Fiat relooks at its own platforms) and may be more limited than management foresees should Chrysler not be able to grow car and unibody CUV share in the US (that is, platforms with more potential commonality with Fiat than the body-on-frame Jeeps and Rams).

TRUCKS & AG EQUIPMENT WILL NOT OFFSET AUTO DECLINE NEAR TERM Fiat’s has guided to a group trading profit of more than €1bn in 2009 (which we see little risk to as we are at €1.090bn) and a net industrial debt of less than €5bn for 2009 (we are at €4.5bn, driven by a €0.6 improvement in working capital in 4Q09). In 2010, Fiat has guided to a trading profit of €1.5bn, and a sales increase of up to 3%, depending on scrappage programme extensions in Italy and elsewhere. Without an extension, which we view as unlikely, we forecast trading profits of €660mn.


8 December 2009 84

FGA earnings likely to fall by over €350mn

Assuming no extension of scrappage schemes in Italy, as well as the spread of pricing pressures in post-scrappage Europe, we expect FGA income to fall by €370mn further in 2010, to a margin of 0.2% vs. 1.6% in 2009.

Figure 144: Trading profit delta of €370mn likely at FGA in 2010E

€mn FGA trading profit 2009 2010E 2011E

Prior year trading profit 714 414 47

Volume -24 -303 56

Price/mix -599 -200 75

Purchasing net 197 200 50

Production cost absorption -200 -283 64

R&D 75 20 10

SG&A 440 200 -25

Other 0 0 0

Yoy change in trading profit -300 -367 230

Current year trading profit 414 47 276

Trading profit margin 1.6% 0.2% 1.2%

Note: trading profit margin = trading profit/revenue Source: Barclays Capital

CNH and Iveco not likely to provide meaningful offset until 2011

At the same time, while we expect a bottoming and modest rebound in CNH and Iveco in 2010, the increase of €75mn and €80mn respectively does not offset the headwinds in FGA:

Figure 145: €75mn delta at CNH in 2010E not enough to offset FGA decline…

€mn CNH trading profit 2009 2010E 2011E


Volume/mix -694 30 46

Price 197 -5 0

Purchasing net -5 5 0

Production cost absorption -151 15 0

R&D/SG&A 137 30 0

Other -192 0 0

Yoy change in trading profit -708 75 46



Note: trading profit margin = trading profit/revenue Source: Barclays Capital


8 December 2009 85

Figure 146: … nor is €80mn Iveco delta in 2010E

€mn Iveco trading profit 2009 2010E 2011E


Volume/mix -1015 40 161

Price -44 -50 -30

Purchasing net 17 10 10

Production cost absorption 41 10 30

BB./used 2 0 0

R&D 49 30 10

SG&A 161 40 15

Other -20 0 0

Yoy change in trading profit -809 80 196




Chrysler likely to survive but contribution modest At its recent five-year plan presentation, Chrysler management and CEO Marchionne outlined an aggressive set of plans to turn around Chrysler. In many respects, the plans were well-founded and ahead of the direst predictions in the market. However, at this point, we prefer to value Chrysler’s potential contribution to Fiat around what we believe to be achievable in the next few years, as opposed to more aspirational and longer term stretch targets. Given what we view as achievable, we see potential for Chrysler to earn an operating income of US$2.5bn in 2013, contributing €0.15 to Fiat EPS and €1.84/share to Fiat value at a 12x P/E multiple. Note even if Chrysler hits management’s more optimistic projections, Chrysler would contribute only €0.45 to Fiat EPS and €5.43 per share to Fiat value (at 12x P/E) some 4 years hence; insufficient, in our view, to justify the recent run up in valuation.

What’s achievable: Survive through 2010 via fixed cost reduction, defend/expand Minivan, Jeep and Ram share, unlock Jeep export markets

Aggressive fixed cost reduction likely lowers EBIT breakeven to about 11mn SAAR

Given the large reductions to date in Chrysler’s fixed cost base, as well as the likely closing 2009 cash balance of US$6bn, we believe that Chrysler likely can survive until the new “Fiat’ inspired product arrives.

When the prior management team at Chrysler filed its “Viability Plan” in February 2008, Chrysler indicated its fixed costs were US$8-$10bn and variable contribution was $3,971/unit but rising to about $5,300-$5,600 in the plan period. Using $8bn of fixed costs and the lower per vehicle contribution implies a breakeven production of 2mn units (or roughly a SAAR (seasonally adjusted annual selling rate) of 12.2mn assuming 10.7% market share); using the higher variable contribution of $5,600 per vehicle would imply EBIT breakeven at 1.4mn units or a SAAR of 8.5mn units.

Chrysler to add only €1.84/share to Fiat value in 2013 on our

assumptions (and still only €5.43 on management’s more

optimistic projections)


8 December 2009 86

In the November 2009 plan, Chrysler indicated it could be at breakeven at annual production of 1.65mn units, and could earn an operating profit of US$2bn at production of 2.2mn. With a change in operating profits of $2bn due to a production increase of 550,000 units, the implied variable profit per unit is $3,636, about in line with the February plan level of $3,971 for 2008, although below that plan’s rather too optimistic later year per vehicle contributions.

Figure 147: Chrysler to breakeven at 11mn US SAAR based on new Nov 09 plan

Chrysler implied breakeven analysis Feb 09 plan Nov 09 plan

Low contrib. High contrib.

Variable contribution per vehicle (US$) 3,971 5,634 3,636

Fixed costs (US$bn) 8.1 8.1 6.0

Units for breakeven (000) 2,040 1,438 1,650

Implied US SAAR (000) 12,181 8,586 11,000

US market share 10.7% 10.7% 10.5%

NA Production/US SAAR 1.6X 1.6X 1.4X

Memo: Nov 09 plan variable contribution analysis

EBIT (US$bn) at: 1.65 mn units 0.0

2.20 mn units 2.0

Change in EBIT (US$bn) 2.0

divided by:

Change in units (000) 550

= Var. contribution per unit $3,636


Assuming that (as the plan guidance indicates) variable contribution is roughly constant over the life of the contract, fixed costs appear to be in the range of -US$4-$6bn over the plan period. Assuming Chrysler's planned level of Canadian, Mexican and export sales relative to US sales (which we believe Fiat may be able to increase) implies Chrysler can breakeven at an 11mn US SAAR.

Figure 148: Chrysler fixed costs: Feb 2009 plan vs. implied in Nov 09 plan

10.5

9.2

8.1

10.210.5

4.3

5.7 5.8

2008 2009E 2010E 2011E

Feb 09 plan Nov 09 plan (est.)

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Feb 09 plan Nov 09 plan (est.)


Chrysler can breakeven at 11m US SAAR (implying

contribution/vehicle of $3,636) per management’s Nov 09 plan


8 December 2009 87

Defensible share in core products Overall, Chrysler’s product plan is directionally sound. The key elements include refreshing vehicles mid cycle/near term, developing new vehicles based on shared platforms with Fiat, introducing more fuel efficient powertrains (downsized, turbocharged ICEs with dual clutch transmissions), defending and expanding the Jeep and Ram truck franchises, and growing export markets, especially for the iconic Jeep.

However, we view Chrysler’s goal of boosting share from 9% in 2009 to 12.6% in 2011 and eventually reaching close to 14% US share as aggressive, and prefer to value Chrysler based on the US share we see as achievable given Chrysler/Dodge/Jeep brand positioning, product portfolio and export opportunities – which in our view would yield 2011 share of 10.3%, with most of the improvement coming from a resumption of fleet deliveries that were stymied in 2009 when Chrysler plants were shuttered.

We see Chrysler’s estimates for Ram and Jeep market share -- 2.4% and 3.3% in 2011 -- as fairly realistic, although we somewhat haircut the shares to 2.2% and 3.0% respectively to reflect the more recent weakness in their performance.

The Ram pickup enjoys a loyal base, and has been successful in the past at eking out share gains. The new Ram brand organization appears to have identified growth opportunities to better segment and penetrate commercial markets. Finally, we believe that pickup trucks are likely to remain about 11% of US sales.

Similarly, Jeep enjoys a strong brand image, especially around the iconic Jeep Wrangler. While Jeep has suffered from some cloned vehicles that stretched the brand, nevertheless Fiat should be able to defend most of the Jeep share.

At the same time, we are more sceptical of management’s aspirations for the Chrysler and Dodge brands, given their long history of market share losses. In particular, unless the mid-cycle product refreshes are extremely successful, by continuing heavy reliance on incentives and fleet sales, we believe Chrysler will be continuing to impair brand equity, making relaunch of the vehicles – even if well designed with Fiat input – more difficult. As a result, we assume share of 1.8% for Chrysler (vs. plan of 2.2%) and 3% for Dodge (vs. 4.4%) – roughly in line with the shares achieved in 2009, which underneath reflects an assumed continued decline in retail share offset by increased fleet deliveries. Overall, we see fleet share increasing from 1.9% in 2009 to 3.1% in 2011, in line with management delivery assumptions, but leading to overall fleet mix of 31% (off our lower market share) vs. 25% in management’s plans (which assumed higher retail sales in Dodge and Chrysler).

On our assumptions, car build in 2011 would be only 20% of the mix, or 330,000 units, versus 429,000 units or 27% in the November plan – thus limiting to some extent synergies with Fiat’s car platforms.

At the same time, we see assumptions for Canada and Mexico as reasonable, and note that the smaller Fiat-inspired vehicles are likely to be received well in those markets. Finally, we believe Fiat’s plans to greatly expand international sales – especially of Jeep – are eminently sensible given the strong Jeep brand image. As a result, we see deliveries reaching 1.7mn units in 2010 and nearly 2mn units in 2011 (note we are using a higher SAAR assumption – 12mn in 2010 vs. 11mn in the Fiat plans). While the swing from 2009 to 2010 of 80% (that is, 760,000 units) appears large, we note that it is explainable due to increased fleet deliveries (about 150,000 units), exports (100,000 units) and non-recurrence of inventory destocking (400,000 units) and overall market growth (130,000 units).

Our forecasts assume 10.3% market share for Chrysler in US

in 2011 (vs. management’s more ambitious 12.6% by 2011 and

14% longer-term targets)

We think management’s estimates for Ram and Jeep

market share are realistic but their expectations for Chrysler and Dodge brands are overly

aggressive


8 December 2009 88

Figure 149: Chrysler truck share likely to increase 180bp 09 vs 11E making car synergies with Fiat less obvious

Chrysler US Share by Brand/Segment Market Share 2011 estimates

Brand Segment 2000 2005 2008 2009 Chrysler BarCap

Chrysler Car 1.3% 1.6% 1.0% 0.6% 0.8%

Chrysler Minivan 1.0% 1.1% 0.9% 0.8% 0.6%

Chrysler Other light truck 0.5% 1.2% 0.6% 0.3% 0.4%

Chrysler Total 2.8% 3.8% 2.5% 1.7% 2.2% 1.8%

Ram Large pickup 2.2% 2.4% 1.8% 1.8% 1.9%

Ram Other pickup/comm'l van 1.4% 0.7% 0.3% 0.2% 0.3%

Ram Total 3.6% 3.1% 2.1% 1.9% 2.4% 2.2%

Dodge Car 2.1% 1.8% 2.0% 1.6% 1.5%

Dodge Minivan 1.6% 1.3% 0.9% 0.9% 0.7%

Dodge Other light truck 1.0% 0.7% 0.8% 0.7% 0.8%

Dodge Total 4.8% 3.9% 3.8% 3.2% 4.4% 3.0%

Jeep 2.9% 2.8% 2.5% 2.3% 3.3% 3.0%

Plymouth 0.5% 0.0% 0.0% 0.0%

Fiat 0.3% 0.3%

GRAND TOTAL 14.5% 13.6% 11.0% 9.1% 12.6% 10.3%

Cars (000 units) 678 579 406 187 439 330

Trucks (000 units) 1,845 1,726 1,047 594 1,161 1,308

memo: % cars 26.9% 25.1% 27.9% 24.0% 27.4% 20.2%


Nevertheless, beyond 2011, even with a higher SAAR assumption we remain below management’s unit volume projections.


8 December 2009 89

Figure 150: Chrysler deliveries to reach 1.7mn units in 2010 based on Barclays Capital US SAAR estimates

Chrysler Sales and Production by area (BC est.) 2008 2009 2010 2011 2012 2013 2014

US SAAR (mn units) 13.5 10.5 12.0 13.5 14.5 16.0 15.4

Chrysler’s US Market share 10.8% 9.0% 10.1% 10.3% 10.3% 10.3% 10.3%

US Sales (000 units) 1,458 945 1,212 1,391 1,494 1,648 1,586

Canada/Mexico sales (000 units) 300 300 300 300 300 300 300

Memo: Canada/Mexico as % of US sales 21% 32% 25% 22% 20% 18% 19%

Exports (000 units) 200 100 200 300 300 400 500

Total Chrsyler N Am Sales 1,958 1,345 1,712 1,991 2,094 2,348 2,386

Inventory build (destocking) 107 -396

Production units 2,065 949 1,712 1,991 2,094 2,348 2,386

Memo: Production/US Sales 1.4x 1.0x 1.4x 1.4x 1.4x 1.4x 1.5x


Figure 151: Chrysler unit sales at 1.65mn in 2010 per Company’s Nov 09 plan

Chrysler assumption per November 09 plan 2008 2009 2010 2011 2012 2013 2014

Chrysler Units 2,065 949 1,650 2,200 2,400 2,600 2,800

US SAAR 13.5 10.5 11.0 12.7 13.8 14.0 14.5

US Market share 10.8% 9.0% 10.5% 12.6% 13.0% 13.6% 13.8%

Production/US Sales 1.42x 1.00x 1.43x 1.38x 1.33x 1.37x 1.40x


Figure 152: Despite higher SAAR assumption, Barclays Capital estimates remain below management’s projections due to lower assumed market share

1,6181,775

2,085 2,120 2,175 2,2272,065

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8 December 2009 90

Given these assumptions, we see 2011 EBITDA at US$4.3bn only somewhat below management projections of $4.5bn, but enough of a difference that we would envision no net income and hence no contribution to Fiat’s equity income. Even in 2013, we see only €0.15 EPS per Fiat share – implying about €1.84 at a 12x multiple.

Even using management’s assumptions, Chrysler would contribute only €0.42 in 2012, or €5/share at 12x – we view this as ‘risky’ three years out (discounting back at 20% a year would lead to a value of €2.50.

Figure 153: Chrysler income statement - Barclays Capital estimates

Year-end December (€mn) 2008 2009 2010 2011 2012 2013 2014

Net Revenue 47.6 16.5 44.1 47.5 50.2 56.4 57.5

Variable Cost -39.4 -13.0 -37.9 -40.3 -42.5 -47.9 -48.8

Variable Profit 8.2 3.5 6.2 7.2 7.6 8.5 8.7

Fixed Cost -10.5 -4.3 -5.7 -5.8 -6.0 -6.0 -6.0

Operating Profit -2.3 -0.9 0.5 1.5 1.6 2.5 2.7

Operating margin -4.8% -5.3% 1.2% 3.1% 3.2% 4.5% 4.7%

Depreciation & Amortization (D&A) 2.1 1.1 2.5 2.8 2.9 3.0 3.3

EBITDA -0.2 0.3 3.0 4.3 4.5 5.5 6.0

EBITDA margin

Depreciation & Amortization (D&A) -2.1 -1.1 -2.5 -2.8 -2.9 -3.0 -3.3

Interest, taxes, etc. -5.7 -2.0 -1.6 -1.5 -1.0 -1.7 -2.2

Net Income/(Loss) -8.0 -2.9 -1.1 0.0 0.6 0.8 0.5

Memo -EPS per Fiat share (€) -€ 0.11 € 0.00 € 0.12 € 0.15 € 0.10

Value per Fiat share at 12x € 0.02 € 1.45 € 1.84 € 1.17


Figure 154: Chrysler income statement per Nov 09 plan

Year-end December (€mn) 2008 2009 2010 2011 2012 2013 2014

Net Revenue 47.6 16.5 42.5 52.5 57.5 62.5 67.5

Variable Cost -39.4 -13.0 -36.5 -44.5 -48.8 -53.0 -57.3

Variable Profit 8.2 3.5 6.0 8.0 8.7 9.5 10.2

Fixed Cost -10.5 -4.4 -5.9 -6.0 -5.5 -5.3 -5.2

Operating Profit -2.3 -1.0 0.1 2.0 3.2 4.1 5.0

Operating margin -4.8% -6.0% 0.3% 3.8% 5.6% 6.6% 7.4%

Depreciation & Amortization (D&A) 2.1 1.2 2.5 2.8 2.9 3.0 3.3

EBITDA -0.2 0.3 2.6 4.8 6.2 7.1 8.3

EBITDA margin

Depreciation & Amortization (D&A) -2.1 -1.2 -2.5 -2.8 -2.9 -3.0 -3.3

Interest, taxes, etc. -5.7 -2.0 -1.6 -1.5 -1.0 -1.7 -2.2

Net Income/(Loss) -8.0 -3.0 -1.5 0.5 2.3 2.4 2.8

Memo -EPS per Fiat share (€) -€ 0.16 € 0.05 € 0.42 € 0.45 € 0.53

Value per Fiat share at 12x € 0.65 € 5.09 € 5.43 € 6.34



8 December 2009 91

Spin-off could unlock significant value but not likely until capacity rationalized and/or new alliance partner added At this point, we do not see significant, realistic upside potential from a spin-off of FGA from other industrial operations for three reasons:

First, while historically, Fiat Group has traded at a discount to the “pure plays” of each of its components (volume car makers, premium car, truck and agricultural equipment), this does not appear to be the case currently, given the depressed earnings and multiples across the truck and agricultural equipment sectors. Our sum-of-the-parts calculation, using current multiples of peer companies is €9 per share, not a significant premium to our €8 target.

Second, with the likely pressures in FGA Europe (leading to a sequential decline in trading profit, in our view), the need to address capacity issues in Italy and the slow pace of profit development at Chrysler (as ‘new’ models will not arrive until 2012), Fiat is unlikely to generate sufficient progress in automotive to generate investor enthusiasm around a spin-out of FGA.

Third, without Opel, Fiat is still well short of its 5mn unit ‘global player’ scale goal. While there had been press speculation around a PSA tie up (perhaps put to rest with PSA’s approach to Mitsubishi), we believe that, given also the difficulty in addressing European capacity, as well as the need for geographic diversification, Fiat may follow the lead of PSA-Mitsubishi and begin the task of looking for alliance partners in Asia. As PSA demonstrates, an Asian partner adds access to faster growth markets, cost sharing across traditional vehicle platforms, and pooling of scarce R&DS around electric vehicles. (For press reports, see Marchionne to Turn Attention to Fiat, by Giancarlo Perini, WardsAuto.com, 19 Nov 2009; Peugeot Mulls Letting it Ride on Mitsubishi, Wall Street Journal, 3 Dec 2009)

Figure 155: Fiat SotP (ex Chrysler) at peer multiples implies share is overvalued at current share price

Unit EUR (m) € per share Remarks

Fiat Group Auto 4,700 4 Average of: 25% EV/FGA Sales, 5x 11E EBIT

CNH 4,600 4 Average of 60% EV/sales, 8X EV/EBIT, Current CNH market cap

Iveco 3,500 3 Average of: 60% EV/sales, 8x EV/EBIT 11E EBIT

Components 2,600 2 25% EV/sales

Chrysler 1,150 1 2013 value at 12X P/E discounted to 2011

SotP EV Operating Business 16,550 13

Industrial Net Cash/Debt (2010E) -4,725 ( 4) FY10E Net Industrial Cash

Pension/other 0 0

Minorities -754 ( 1)

Total EV 11,071 9


Rating We are initiating coverage with a 3-Underweight rating, believing that investors are underestimating the headwinds faced in 2010 while overvaluing short term the longer-term Chrysler option and contribution to Fiat core earnings.


8 December 2009 92

Valuation methodology We value the Fiat share based EV/sales and EV/EBITDA metrics against Fiat’s historical trading range, with a reference to the SotP methodology (see Figure 155 above) based on peer multiples for the various divisions to confirm our valuation.

EV/sales

Fiat has historically traded at a six-year historical average of 28% EV/sales. But at current market price is trading at 35% 2010E EV/sales on our estimates, highlighting our belief that the share is significantly overvalued at present. The OEM sector average range is 27%. At our €8 price target, Fiat would trade at 28% EV/sales, exactly in line with its historical average.

Figure 156: Below consensus estimates

Fiat 2010E Barclays Consensus Variance (%)

Revenue (€mn) 48,036 49,324 -2.7%

EPS (€) 0.05 0.38 -660


Figure 157: Fiat current share price looks overvalued in near-term based on historical avg EV/sales metrics

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Adjusted EV/Sales 6-yr historical avg


EV/EBITDA

Our EV/EBITDA looks at adjusted industrial EV (backing out financial services) over industrial EBITDA. Historically, Fiat has traded at a 6-year average of 4.3x EV/EBITDA (vs. 3x for the European sector as a whole). Looking out to 2011E our below consensus EBITDA estimates put Fiat at 4.1x at current share price. However, given the 2010 headwinds we believe this discount is justified, and our target is based on 4.0x 2011 EBITDA, from which we derive a €8 price target.


8 December 2009 93

Figure 158: Fiat historical and forecast PE and current share price

0.0x

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4.0x

6.0x

8.0x

10.0x

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Adjusted EV/EBITDA 6 year historical avg

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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An average of both these valuation metrics leads us to set a €8 price target for the share.


8 December 2009 94

Figure 159: Potential catalysts

Date Event

22-Jan-10 Q4 09 results

27-Mar-10 AGM

23-Apr-10 Q1 10 results

22-Jul-10 Q2 10 results

17-Sep-10 Sep10 expiry


Figure 160: Peer group

Blg 9m IV 3m RV

RNO FP 46% 44%

PAH3 GR 45% 40%

VOW GR 44% 44%

F IM 40% 44%

DAI GR 37% 38%

BMW GR 37% 36%


Colin Bennett +44 (0)20 777 38332

[email protected] Barclays Capital, London

Arnaud Joubert

+44 (0)20 777 48344 [email protected]


Abhinandan Deb +44 (0)20 777 32481


Anshul Gupta

+44 (0)20 313 48112 [email protected]


Fiat Sep-10 €10(96%)-€8(77%) put spread

Pay: €0.75 (7.2%), ref €10.45, delta 18% (IV c.42-46%, 3m RV c.45%)

We believe that Chrysler’s turnaround plan is viable. However, we are more conservative than management’s optimistic market share and earnings projections, especially given the difficulty of repositioning Chrysler’s current incentive driven line-up.

In October 2009, Fiat soared €2 leading up to the forecast that Chrysler would make a profit inside two years.

As Chrysler was attributed little if any value before this date, and as this €2 rise is above our estimated Chrysler total value of €1.50/share by 2012, current valuations have significant downside potential.

Figure 161: Max profits reached when Fiat trades back to September levels

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Second put strike (peak profits will occur here)

Fiat rose 18% in three days after forecasting Chrysler operating profit within two years

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Fiat rose 18% in three days after forecasting Chrysler operating profit within two years


Fiat particularly exposed to end of cash for clunkers Fiat’s offering is heavily reliant on cheaper cars, which caused results to be substantially

flattered by various cash for clunkers schemes.

Fiat is therefore likely to be hit harder than other auto firms as volumes fall, price competition increases and government support schemes expire.

Should Italy extend its cash for clunkers scheme, which is due to expire at the end of December 2009, the government is likely to insist Fiat moves production from other cheaper countries towards Italy. The future downside due to the higher Italian cost base would cap any upside should cash for clunkers be extended (in our view, even if extended the scheme is unlikely to be impactful).


8 December 2009 95

Credit Perspective Barclays Capital credit analysts, Rob Perry and Darren Hook, rate Fiat’s debt Overweight. They believe Fiat has significantly improved its liquidity position in recent months following the issuance of 3 benchmark bonds and this will have gone some way to stabilise Fiat's current high BB rating. Nevertheless they note that credit metrics remain below requirements and while they expect material improvement through next year, credit ratios are likely to remain at levels more consistent with a mid BB rating, in their view.


8 December 2009 96

Figure 162: Fiat key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E


Industrial EV/sales 28% 40% 31% 36% 35% 33% 25%


Industrial EV/Clean EBIT 8.5x 7.8x 6.2x 21.9x 39.2x 18.3x 9.4x

P/E 12.9x 12.8x 8.8x 109.6x 205.6x 29.0x 10.0x

FCF Yield 8.0% 8.8% -33.4% 0.2% 9.4% 2.7% 8.3%

Price/sales 27% 43% 24% 27% 27% 26% 24%


Dividend yield 1.4% 2.0% 0.0% 0.1% 0.5% 1.2% 2.0%


EV/sales 28% 40% 31% 30% 28% 27% 20%

EV/clean EBITDA 3.3x 4.1x 3.3x 3.8x 4.1x 3.5x 2.3x

EV/clean EBIT 7.3x 7.0x 5.4x 15.6x 27.9x 12.9x 5.6x

P/E 12.9x 12.8x 8.8x 84.6x 158.7x 22.4x 7.7x

FCF yield 8.0% 8.8% -33.4% 0.2% 12.2% 3.5% 10.7%

Price/sales 27% 43% 24% 0% 1% 0% 0%


Dividend yield 1.4% 2.0% 0.0% 0.1% 0.6% 1.5% 2.6%


Risks to price target Upside risks to our price target are as follows:

External risk – macroeconomic factors outside the control of the company, leading to a stronger demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

Risks to our commonality assumptions if there were to be a more rapid turnaround at Chrysler than we currently forecast

More rapid rebound in truck and/or agricultural equipment than we assume in our forecasts could provide further upside to the share


8 December 2009 97

Figure 163: Fiat Group income statement, 2006A-2012E


Net Revenues 51,832 58,529 59,380 49,575 46,133 47,985 53,525

Cost of Sales (43,888) (50,629) (49,423) (42,701) (40,178) (41,426) (45,438)

Gross Profit 7,944 7,900 9,957 6,874 5,955 6,560 8,087

Memo: Gross Margin (% of sales) 15.3% 13.5% 16.8% 13.9% 12.9% 13.7% 15.1%

SG&A 4,697 6,317 5,075 4,388 4,087 4,124 4,586

Memo: SG&A (% of sales) 9.1% 10.8% 8.5% 8.9% 8.9% 8.6% 8.6%

Research & Development 1,401 1,600 1,497 1,321 1,233 1,165 1,301

Memo: R&D (% of sales) 2.7% 2.7% 2.5% -2.7% -2.7% -2.4% -2.4%

Other income/(expense) 105 50 (23) (104) 42 (29) (29)

Trading profit/(loss) 1,951 3,233 3,362 1,060 676 1,241 2,172

Investment Income/(Expense) 607 190 20 2 0 0 0

Restructuring Costs (gains) (450) (105) (165) (165) 0 0 0

Other unusual income/(expense) (47) (166) (245) (111) 0 0 0

EBIT 2,061 3,152 2,972 786 676 1,241 2,172

Financial Income (expense) 607 190 (947) (699) (740) (700) (675)

Other Financial Income/expense (450) (105) 0

Result from Investments (47) (166) 162 7 16 19 241

Pre-Tax Income 2,061 3,152 2,187 95 (48) 561 1,738

Income tax (490) (719) (466) (28) 127 (31) (347)

Memo: Tax rate -24% -23% -21% -30% 265% 5% 20%

Net before Minority Interest 1,571 2,433 1,721 66 79 530 1,391

Minority Interest (86) (101) (109) (27) (17) (17) (17)

Profit/loss for the period 1,485 2,332 1,612 39 62 513 1,374

Adjusted Group Net , ex special items 887 1,889 1,902 219 62 513 1,374

No Shares (average) 1,271 1,262 1,240 1,237 1,237 1,237 1,237

EPS € 1.17 € 1.85 € 1.29 € 0.03 € 0.05 € 0.42 € 1.11

EPS - adjusted € 0.70 € 1.50 € 1.53 € 0.18 € 0.05 € 0.42 € 1.11

Dividend € 0.16 € 0.40 € 0.00 € 0.00 € 0.04 € 0.12 € 0.23



8 December 2009 98

Figure 164: Fiat group divisional revenue & trading profit, 2006A-2012E


Segment revenue

Automobiles 25,668 29,174 29,683 28,046 24,967 25,916 29,388

Fiat Group Automotive 23,702 26,812 26,937 25,906 22,811 23,515 26,850

Maserati 519 694 825 420 437 455 473

Ferrari 1,447 1,668 1,921 1,721 1,719 1,946 2,064

Eliminations (91) (159) (303) (152) (136) (141) (160)

Agri and Const Equipment (CNH) 10,527 11,843 12,723 10,107 10,310 10,619 11,150

Trucks and Comm. Vehicles (Iveco) 9,136 11,196 10,768 6,808 6,863 7,497 8,530

Components/Prod Systems (FPT MM Teksid Comau):

FPT Powertrain Technologies 6,145 7,075 7,000 5,192 4,665 4,762 5,383

Components (Magneti Marelli) 4,455 5,000 5,447 4,666 4,192 4,279 4,837

Metallurgical Products (Teksid) 979 783 837 568 510 521 573

Prod Systems (Comau) 1,280 1,089 1,123 736 661 675 763

Component eliminations (432) (388) (396) (447)

Other business 1,050 1,071 1,092 1,114

Eliminations (6,947) (6,459) (6,720) (7,506)

Group Revenues 58,190 66,160 67,581 50,227 46,392 48,244 53,784

Segment trading profit

Automobiles 441 1,093 1,102 662 300 603 1,102

Fiat Group Automotive 291 803 691 414 47 276 734

Maserati (33) 24 72 9 15 20 25

Ferrari 183 266 339 239 239 307 342

Agri and Const Equipment (CNH) 737 990 1,122 392 423 469 549

Trucks and Comm. Vehicles (Iveco) 546 813 838 30 110 306 462

Components/Prod Systems (FTP MM Teksid Comau)

FPT Powertrain Technologies 168 271 166 4 (75) (61) 32

Components (Magneti Marelli) 190 214 174 48 (23) (10) 73

Metallurgical Products (Teksid) 56 47 41 (1) (9) (7) 19

Prod Systems (Comau) (66) (23) 21 (22) (34) (31) (18)

Other business and eliminations (24) (15) (27) (48)

Trading profit 2,072 3,405 3,464 1,089 676 1,241 2,172



8 December 2009 99

Figure 165: Fiat industrial balance sheet, 2006A-2012


Intangible assets 6,325 6,420 6,950 7,032 7,032 7,032 7,032

Goodwill 2,756 2,635 2,600 0 0 0 0

Other intangible fixed assets 3,569 3,785 4,350 0 0 0 0

PPE 10,528 11,239 12,509 12,614 12,269 12,094 12,251

Investment and other financial assets 3,912 4,357 3,756 3,798 3,498 3,364 3,203

Deferred tax assets 1,721 1,737 2,225 2,508 2,508 2,508 2,508

Total Non-current assets 22,486 23,753 25,567 26,103 25,458 25,150 25,146

Inventories 8,491 9,929 11,341 11,259 7,024 10,696 7,531

Trade receivables 5,068 4,444 4,301 5,007 2,366 5,295 3,259

Receivables from financing activities 2,891 4,606 6,448 5,713 5,713 5,713 5,713

Other receivables 2,806 3,052 2,443 1,945 1,945 1,945 1,945

Accrued income and prepaid expenses 226 224 761 1,302 1,302 1,302 1,302

Current financial assets:

Current equity investments 26 38 38 38 38

Current securities 134 164 164 164 164

Other financial assets 748 672 672 672 672

Cash and cash equivalents 7,237 6,391 2,604 7,523 8,548 9,307 10,121

Current assets 26,719 28,646 28,806 33,623 27,772 35,132 30,745

Assets held for sale 332 83 30 20 20 20 20

Total assets 49,537 52,482 54,403 59,746 53,250 60,301 55,910


Equity 9,362 10,606 10,350 10,558 10,637 11,118 12,361

Industrial stockholders' equity 10,036 11,279 11,101 11,312 11,391 11,872 13,115

Provisions:

Employee benefits 3,750 3,581 3,351 3,311 3,311 3,311 3,311

Other provisions 4,721 4,788 4,638 4,619 4,619 4,619 4,619

Debt: 11,555 10,706 14,522 18,758 18,758 18,758 18,758

Other financial liabilities 98 153 1,078 536 536 536 536

Trade payables 12,637 14,751 13,216 14,365 7,789 14,360 8,727

Other liabilities 5,064 5,990 6,052 6,159 6,159 6,159 6,159

Deferred tax liabilities 1,676 1,234 445 686 686 686 686

Industrial Total Liabilities 39,501 41,203 43,302 48,434 41,858 48,429 42,796

Total equity and liabilities 49,537 52,482 54,403 59,746 53,250 60,301 55,910

Balance sheet measures:

Inventory days 69.3 69.4 79.5 98.6 85.0 80.0 75.0

Receivable days 36.0 30.2 27.4 35.1 30.0 30.0 30.0

Payable days 103.4 103.2 104.5 120.3 103.0 100.0 95.0

Capex percent of sales 5.7% 6.4% 8.5% 6.0% 5.4% 5.4% 5.4%



8 December 2009 100

Figure 166: Fiat industrial cash flow, 2006-2012E


Industrial Cash Flow from Operations:

Industrial Net result before minority. interest 1,151 2,054 1,721 (317) 79 530 1,391

D&A (net of vehicles sold under buy-back commitments) 2,639 2,667 2,805 2,744 2,767 2,691 2,653

(Gains)/losses and other non monetary items (921) (704) (119) (138)

Dividends received 180 203 115 186 300 133 161

Change in provisions and other 255 (13) (149) (165) 0 0 0

Change in deferred income tax 12 (126) (532) (289)

Change in working capital 679 1,675 (3,604) 1,056 301 (30) (432)

Industrial Cash flows from operating activities 3,995 5,756 156 3,045 3,447 3,325 3,773

Industrial Cash Flow from Investments:

Investments in PPE (2,854) (3,666) (4,980) (2,889) (2,422) (2,517) (2,810)

Equity investments and unconsolidated. subs (1,633) (136) (152) (46)

Proceeds from the sales of non current assets 1,574 680 204 71

Net change in receivables from financing activities 149 41 10 46

Change in current securities 2,322 (2,724) 24 (32)

Other changes -1194 698

Industrial cash flows from investment activities (442) (5,805) (6,088) (2,152) (2,422) (2,517) (2,810)

Industrial Cash Flow from Financing:

Net change in financial payables and other financial assets/liabilities (2,256) (425) 3,840 4,015

Increase in capital stock 22 (390) 14 12

(Purchase)/Disposal of treasury stock -238 0

Dividends paid (23) (310) (546) (32) 0 (49) (148)

Cash flows from investing activities (2,257) (1,125) 3,070 3,995 0 (49) (148)

Translation exchange differences (102) 11 (82) 31

Industrial change in cash and cash equivalents 1,194 (1,163) (2,944) 4,919 1,025 759 815

Cash and cash equivalents at beginning of period 6,180 7,237 6,391 7,109 7,523 8,548 9,307

Cash and cash equivalent at end of period 7237 6391 2,604 7,523 8,548 9,307 10,121

Net industrial cash (debt) (1,773) 355 (5,949) (5,450) (4,725) (4,100) (3,446)



8 December 2009 101

PEUGEOT – STRONG MODEL CYCLE, BUT UNDERWHELMED BY “NEW” STRATEGY – 2-EQUAL WEIGHT RATING

We are initiating coverage of Peugeot with a 2-Equal Weight rating and €26 price target because despite the company’s strong product cadence, the right mix of fuel efficient vehicles and the new, energised management team, we remain more cautious than the market on the demand side of the equation. We also believe that too much credit has already been given for the achievement of CEO Philippe Varin’s new strategy. Whilst we believe that product renewal during this period, particularly at the Citroen brand, will be well received by the market, we are concerned that too much of the current strategy relies on top-line growth. Another key bull argument for the stock has revolved around press speculation of future M&A activity. Whilst we can see the long-term strategic rationale behind Peugeot’s announcement last week of a closer partnership with Mitsubishi, we think once excitement of this potential deal fades, investors will be better in the mid-term to play the global-scale/alliance angle through Renault-Nissan, which not only has far greater scale but also has the benefit of a whole decade of experience in running an alliance. Renault is also at least six months further ahead in its strategy of taking the alliance to a new level and eking out further commonality/modular synergies. Additionally, we believe that until investors are given better visibility regarding the likely financing for Peugeot’s proposed tie-up with Mitsubishi, the share will likely be pressured by concerns over dilution or an increase in gearing.

Likewise, whilst we can in theory see the rationale for a potential tie-up with Fiat (as per numerous press articles for over 12 months), we believe that in reality political agendas would make it near impossible to reap significant synergies from such a deal. Moreover, we think that a Mitsubishi tie-up would make its less likely for PSA to look at a European partner anytime soon. Recent acquisition activity at Faurecia, following the EMCON announcement, has also brought the possibility of a disposal of Peugeot’s current 70.8% stake (to be diluted to 57% following the EMCON deal and to 51% on exercise of the OCEANE convertible bond) back to the forefront. We agree that there is significant potential for turnaround at loss-making Faurecia, but we believe that this is already a well-understood theme, particularly amongst the French investment community.

Whilst we struggle to underweight a stock with so many opportunities for improvement in the next 12 months and where there is potential for upside surprise from a balance sheet perspective were a buyer to be found for Faurecia, at the same time we are concerned that market estimates for Peugeot’s ability to retain cost cuts in 2010E are overly optimistic and we think that the share is already crediting M&A upside potential. We are therefore initiating coverage with a 2-Equal Weight rating and, using a combination of a SotP methodology and peer EV/EBITDA multiples, we derive a €26 price target.

For equity investors who are looking for exposure (delta) to the underlying equity, but with the defensive characteristics of downside protection, senior status, an income advantage and strong takeover and dividend protection features we recommend Peugeot’s 2016 convertible (for further detail please see convertible section).

PEUP.PA / UG FP




Price (04-Dec-2009) €24.18

Potential Upside 8%


8 December 2009 102

Figure 167: PSA – headline data and valuation multiples (at current share price), 2008-11E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 54,356 47,313 47,903 51,135 53,115

EBIT 550 (681) 193 1,523 2,044

EBIT margin (%) 1.0 -1.4 0.4 3.0 3.8

BC EPS € (1.51) (6.28) (1.90) 2.87 4.88

Consensus EPS € - (5.03) (0.33) 3.29 4.88

Industrial EV/sales (%) 13 10 13 8 6


P/E ratio (%) (18.5x) (3.3x) (10.9x) 7.2x 4.3x



Positives:

Success in product cadence helps drive sector-leading capacity utilisation, which could further capitalise upon via a strategic alliance with Mitsubishi

Reinvigorated (new) management focusing on long-term strategy

Widest range of fuel efficient vehicles in the sector

Faurecia turnaround could drive disposal opportunities (although we believe that this is well anticipated, at least by French analysts)

Risks:

Too much expectation placed on new strategy which, at least in the near term, differs very little from CAP 2010 and is likely to disappoint on a net basis

Pay back from scrappage incentives likely to be higher than market anticipates

Lack of geographical scope means top-line targets are much harder to achieve

Lack of near-term operating earnings keeps attention on debt and makes investment grade credit rating tough to achieve

Strategy presentation disappoints

High hopes were entertained in the market following the appointment of ex-Corus CEO Philippe Varin, who arrived with a prior record of turning around the ex-British Steel company, via deep cost cutting and a solid refinancing plan. Indeed, one of his first actions on taking the helm at Peugeot in June 2009 was to streamline the existing management team into just eight members, responsible for strategy and performance objectives. Therefore there was a great deal of expectation surrounding November’s Investor Day when Varin first presented to analysts his new strategy objectives for Peugeot. The plan revolves around a targeted €3.3bn improvement in Automobile EBIT 2010-12, via a linear progression of savings in three key areas:


8 December 2009 103

1. 30% of savings are to come from sales and marketing: driven by market share momentum in Europe - based both on growth in the business-to-business segment and new model launches; improved brand management and expansion of service offerings

2. 15% improvement is expected in high-growth or emerging markets – China (non-consolidated), Russia and Latin America

3. the remaining bulk (55%) of savings are to be cost-driven - based on improvements in capacity utilisation, productivity and SG&A

Figure 168: Peugeot targets €1.1bn per annum gross EBIT savings

Lever % €mn/annum €bn 2010-12 Drivers/targets

Sales & Marketing 30 330 1.0 Market share momentum

Brand management

Services

High-growth markets 15 165 0.5 China Lat Am, Russia

Production, development, SG&A 55 600 1.8

Of which:

Capacity utilisation 25 270 0.8 Increased from 81% to 105%

Productivity 18 200 0.6 hrs/vehicle -20%

SG&A 12 130 0.4 -€400m

Total 100 1,100 3.3


Strategy overly dependent on top-line growth Whilst not a wholly unrealistic strategy, we struggle to find much to differentiate it from any of its peers in the sector, all of whom are targeting market share gain, increased capacity utilisation via improvements in commonality and geographical expansion. We were rather disappointed that so little new was offered to investors at Peugeot’s investor day 12 November 2009. The “new” 2010-12 strategy seemed rather a revamp of predecessor Streiff’s CAP 2012 strategy, which likewise targeted product strategy, productivity, capacity utilisation and quality. The plan, perhaps unsurprisingly given current market conditions, does not lay out any specific margin targets. Whilst we believe that product renewal during this period, particularly at Citroen brand, will be well received by the market, we are concerned that too much of the current strategy relies on top-line growth. Management did not give their internal targets for market share growth, nor did they share with investors their assumptions for global demand over the targeted period. Since we believe our own assumptions for 2010 auto demand in Europe to be significantly below consensus, we are concerned that the market is giving too much credit to likely achievement of Peugeot’s top-line strategy.

We believe that management is targeting 140bp of market share

gain by 2012E. We credit only 40bp of additional share and just

€670m of the targeted €1.5bn savings (from sales & marketing

and high growth countries).


8 December 2009 104

Though all European OEMs target market share gain, of course not all of them can be successful in achieving it. However, we do believe PSA’s product launch offensive in the next three years will set it apart from its closest peers (see detail below on product cadence). We therefore base our current forecasts on 40bp of market share gain by 2012 (despite 2010’s scrappage pull back), whereas we believe management may be targeting a much more aggressive 140bp increase.

Where we also have concerns about the success of the plan is the lack of detail regarding market demand assumptions over the three-year period. Consensus, we believe, is currently at least 350bp too high (ranging from 8-10% fall in sales) for European demand in 2010E, whereas based on our detailed scrappage model (see front section of report for further detail) we forecast European (EU 27 +EFTA 3) sales down -12.5% in 2010E. We are concerned that PSA’s demand assumptions may also be over optimistic. We expect the European market to grow by only 5% (or 700,000 vehicles) cumulatively from year-end 2009 to 2012E, with Peugeot’s core A & B segments likely down 200bp in share, or 700,000 units.

Figure 169: A to D volume market segment share 2006-12E

Segment (%) 2006 2007 2008 2009 2010 2011 2012

A - Basic 8.2 8.4 10.5 13.7 11.4 11.5 12.0

B - Small 29.9 29.7 29.5 33.1 31.4 32.8 32.8

Memo: A + B 38.1 38.1 40.0 46.8 42.8 44.3 44.8

C - Lower Medium 31.4 31.9 31.4 29.6 32.6 31.8 31.0

D - Upper Medium 9.6 8.4 8.0 7.0 6.7 6.2 6.1

Memo: C + D 41.0 40.3 39.5 36.6 39.3 38.1 37.1

Memo: A - D 79.1 78.4 79.4 83.4 82.1 82.4 81.9

Total Europe (units mn) 15,819 15,960 14,740 14,000 12,252 13,300 14,700

YoY chg in sales +3.7% +0.9% -7.6% -5.0% -12.5% +8.6% +10.5%


By contrast, we see the European LCV market - one of PSA’s most profitable markets and the segment in which it has the top spot with market share peaking at 27% in 2009 - recovering from its low of 2009. We expect the LCV market to grow 130bp from 2009’s level when the segment accounted for just 9.2% of sales in the overall W EU market. We expect this growth to provide an extra 45,000 vehicles for PSA based on our 2012 market assumption, boosting Peugeot’s margin performance by c.€230mn. However, using an overall contribution margin of €3,000/vehicle, our estimated positive total volume impact on EBIT for the company in the next three years is only €670mn, or 55% behind the company’s €1.5bn plan.

Figure 170: LCV segment market share 2006-12E

LCV Segment 2006 2007 2008 2009 2010 2011 2012

LCV units sales (mn) 1.73 1.82 1.71 1.35 1.38 1.53 1.60

Van share of EU market (%) 10.3 10.8 11.1 9.2 10.5 11.0 10.5

PSA share of Van market (%) 21.6 21.4 22.1 27.3 26.5 25.0 24.0


Going forward, we expect some renormalisation of mix.


8 December 2009 105

Realistic targets for productivity and SG&A savings Like many of its competitors, PSA targets a reduction in vehicle diversity (or stage 2 ‘commonality’ on the road to a full modular production process). This, along with optimisation of plant occupation and the rollout of the PSA excellence system across the group it believes will improve its production hours per vehicle by 20%. Likewise, commonality in repeat components and streamlining of suppliers it believes will increase development productivity by 20%. When combined with €400m of SG&A savings over the next three years, management expect a margin delta of €1.1bn. In this area we give the company full credit for the achievement of its targets.

Figure 171: We credit PSA with €2.2bn cost savings by 2012E

Lever Barclays Capital estimates (€mn) PSA plan Variance

2010E 2011E 2012E 2010-12E 2010-12E (%)

Sales & Marketing (330) 500 150 320 990 -68 High-growth markets 200 40 110 350 495 -29 Capacity utilisation 240 (90) 260 410 800 -49 Productivity 150 200 250 600 615 -2 SG&A 200 150 50 400 400 0 Total savings 460 800 820 2,080 3,300 -37 Other tailwinds/ (headwinds)* (40) 150 (500) (390) Total EBIT change YoY 420 950 320 1,690 Automobile EBIT (375) 575 895

Source: Company data, Barclays Capital *incl FX, raw materials, price/mix and warranty

Lack of geographical scale remains a concern despite strengthening Mitsubishi co-operation We had expected more detail at the strategy presentation on how the company plans to gain market share in its key growth regions – China, Russia and Latin America – given that this is an area of historical weakness for the group, both in terms of volumes and profitability.

Figure 172: 79% sales in Europe leaves Peugeot under-exposed to highest growth markets

France26%

Rest of WE44%

C&E Europe (ex-Russia)

7%

Russia2%

Mercosur9%

China6%

ROW6%


With only 21% of unit sales in non-European countries and a

much lower percentage of revenues, PSA’s targeted €0.5bn

savings from high-growth countries seems overly optimistic


8 December 2009 106

Management did not lay out any plans to expand into new high growth markets, preferring instead to focus on how to improve those regions (China, Russia and Brazil) already covered. And yet PSA currently lags far behind its European peers (notably its key French competitor, RNO) in terms of geographical breadth, and even in those high growth markets that it does service, the company’s market share remains far below that of its volume competitors.

Figure 173: PSA lags European peers in BRIC market exposure, even with Mitsubishi

Share Rank

Group Brazil China India Russia Total BRIC Brazil China India Russia

Porsche-VW Group 20.6% 11.0% 1.4% 4.5% 10.6% 2 2 10 8

Renault-Nissan Group 5.8% 3.8% 2.0% 28.9% 8.0% 6 12 9 1

Fiat Group 24.9% 0.5% 0.4% 2.6% 5.1% 1 24 12 10

PSA/Mitsubishi 0.0% 0.0% 0.0% 0.0% 0.0% 5 13 14 5

PSA 6.1% 2.3% 0.0% 2.8% 2.8% 5 15 - 10

Mitsubishi 1.5% 1.1% 0.2% 4.4% 1.6% 10 20 13 8

BMW Group 0.1% 0.6% 0.1% 0.7% 0.5% 14 23 16 16

Daimler Group 0.4% 0.4% 0.2% 0.6% 0.4% 11 25 15 21


A strategic alliance with Mitsubishi Motors, as Peugeot announced on 3 December is currently being discussed would give Peugeot better geographical spread, since 55% of Mitsubishi’s sales are in Asia, along with a very small presence in North America (though only a 0.5% market share). However, Mitsubishi adds relatively little in BRIC countries, only significantly improving pro forma share in Russia (pro forma 5th rank vs. 10th and 8th for each company) and with Mitsubishi having only a 1.4% share of the overall global car market, or 1mn units per annum, this would not put the alliance any where near on the scale of the Nissan-Renault partnership. Indeed, Mitsubishi does not have more than 5% market share in any countries other than the Philippines and Taiwan where it has 13% and 15% respectively.

Figure 174: Mitsubishi’s sales would provide only marginally greater geographical breadth for PSA

Asia55%

Eastern Europe15%

North America12%

South America7%

Western Europe11%



8 December 2009 107

Peugeot standalone should grow by 140,000 vehicles in high growth countries by 2012E

On the back of planned new models, we do credit 17% sales growth for Peugeot in its ‘rest of world’ (ie, non-European) markets by 2012E, but this only equates to an extra 140,000 vehicles. We expect PSA’s four new model launches and new powertrain plant in Latin America to aid fixed cost absorption in the region and with the Kaluga plant coming online from 1Q10, losses in Russia should start to reduce. However, we still expect the incremental contribution to be significantly lower in these regions than in Europe, and thus forecast only 52% (€350mn) of the €670m EBIT volume effect over the next three years to come from high-growth regions, as opposed to management’s €500m target.

Figure 175: Our PSA estimates incorporate 40bp of European market share growth which equates to a cumulative €670mn additional EBIT 2010-12E

Unit sales data: 2008 2009E 2010E 2011E 2012E

Unit sales W Europe (000s) 2,079 1,871 1,778 1,902 1,940

Unit sales Rest of Europe (000s) 204 163 168 175 181

Unit sales ROW - ex-China (000s) 798 774 821 870 913

Group consolidated unit sales (ex-China) 3,081 2,809 2,766 2,947 3,034

Memo: Unit sales growth W Europe (%) -10.5 -10.0 -5.0 7.0 2.0

Memo: Unit sales growth Rest of Europe (%) -6.2 -20.0 3.0 4.0 3.5

Memo: Unit sales growth ROW (%) 17.6 -3.0 6.0 6.0 5.0

Memo: Total Unit sales growth (yoy) -4.3 -8.8 -1.5 6.5 3.0

Estimated incremental contribution per unit (€) 3,000 3,000 3,000 3,000 3,000

Volume EBIT Delta (€mn) (1,707) (820) (130) 540 260

Of which Europe (860) (730) (330) 500 150

Of which ROW (850) (90) 200 40 110


Capacity utilisation to aid recovery We do credit PSA with superior capacity utilisation, following recent action at Aulnay and Rennes which reduced French capacity by 250k units in 2008-09. We expect the group to reach close to 95% utilisation rates by 2012E (a significant improvement from 2008’s 72% level and 78% in 2009E). However, based on our own sub-consensus view of the European market going forward, we struggle to credit management’s own more aggressive targets of 105% capacity utilisation by 2012E.

We target €410mn of savings as a result of capacity utilisation (at

94% utilisation rates) – some way behind management

targets of €800mn EBIT delta (at 105% utilisation)


8 December 2009 108

Figure 176: New models to drive above average EU capacity utilisation rates from 2010E

55%

60%

65%

70%

75%

80%

85%

90%

95%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

PSA capacity utilisation %

55%

60%

65%

70%

75%

80%

85%

90%

95%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E

PSA capacity utilisation %


With management guiding to 30bp improvement in EBIT for every 1pp improvement in utilisation, a 94% utilisation rate would imply an EBIT delta of €510mn by 2012E (whereas the company targets a more optimistic utilisation rate of 105% or €800mn EBIT delta). However, we are slightly more conservative than management on their ability to retain the full €30m per percentage point on a gross level and therefore forecast just €410mn of capacity savings over the next three years.

Figure 177: We credit PSA with only €400mn of its targeted €800mn of savings from increased capacity utilisation rates

BC estimates PSA Targets BC estimates PSA Targets Variance

Lever 2012E utilisation (%) 10-12E EBIT delta (€mn) %

Capacity utilisation 94% 105% 410 800 -49


Lack of scale mitigates capacity strength

Whilst PSA’s superior capacity utilisation will aid marginal contribution per vehicle, the company’s lack of scale on its key platforms is a notable negative. When compared with its closest peer Renault (which has the benefit of cross-platform sharing with its alliance partner Nissan), PSA’s scale credentials are distinctly lacking. Indeed, with many in the industry forecasting that 1mn units per platform is a necessary level for future profitability, Peugeot falls short in particular on its PF3 but also on its PF1 platforms. Whilst any closer partnership with Mitsubishi would aid this lack of capacity, it would not provide enough scale to put Peugeot on a par with the Renault-Nissan alliance. Speculation in the press has previously focused more on the likelihood of a PSA-Fiat tie-up as this would provide the necessary scale across platforms. However, we question the chance of such an alliance reaping significant synergies in reality, due to the political sensitivity of reducing capacity. We also note the Peugeot’s management are focused in the short term on internal restructuring before turning to any major external actions.

PSA is therefore likely to continue to fall short of competitors (other than Fiat) in terms of sheet scale, although is likely to have a moderate level of commonality, in our view.


8 December 2009 109

Figure 178: Manufacturer’s scale vs estimated commonality – key C platforms

Honda

Ford

ToyotaFiat

GMPSA

Renault-Nissan

VWHyundai

0 1,000 2,000

Scale - units 000

Deg

ree

of c

omm

onal

ity HIGH

MED

LOW


Figure 179: PSA lacks scale on its global production platforms compared to rival RNO-Nissan group (000’s units) – 2011E

233

1,1321,372

994

745

PSA PF1 (207) Renault-Nissan B(Clio)

PSA PF2 (308) Renault-Nissan C(Megane)

PSA PF3 (408) RNO-Nissan D(Laguna)

Europe Asia Middle East/Africa South America

1372


Superior product cadence and strength in LCVs to boost margin

A second key area of strength for PSA lies in its upcoming product portfolio. It is a well argued bull case among analysts that Peugeot’s product renewal schedule is likely to be one of the strongest, if not the strongest, in the industry in the next three years. We concur with the argument that it is not only the frequency of new products coming to market but also the diversity and success in design that is likely to drive earnings upside for the company and which makes us credit PSA with a strong increase in market share. We also think the mix of new model launches, with a focus on C&D segments, will help the company capitalise on our belief that these will be the fastest growing segments in the next three years.


8 December 2009 110

Figure 180: PSA’s current mix in C & D segments is likely to be boosted by new model launches from Citroen brand in particular

0%5%

10%15%20%

25%30%

35%40%

A -

Bas

ic

B -

Smal

l

C -

Low

erM

ediu

m

D -

Upp

erM

ediu

m

E -

Exec

utiv

e

SUV

Van

Oth

er

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

PSA Group Industry avg

Source: JD Powers and Barclays Capital

Whilst the scrappage pull back in 2010E is likely to see a 390bp YoY decline in the A&B segment (traditionally the company’s key segments), product renewals, particularly for the Citroen brand, are set to come thick and fast in the C&D segments. In the front section of this report we argued that the C&D segments are the segments likely to grow the fastest in the next few years (we expect 150bp of share gain 2009-11E). The extension to the breadth of the company’s model range should help shelter from the worst of the post-scrappage declines in the small car segments. Three of 2009’s new products – C3 Picasso, 3008 and 5008 – are all new additions to the company’s existing range and from 2010 the new ‘Distinctive’ Citroen range is launched, beginning with the DS3 and then extended to the C&D segments with the DS4 and DS5. We believe this range will prove highly successful and will not only accord with current customer sentiment but provide an opportunity to boost incremental margin by providing a higher pricing point for the Citroen brand.

A raft of new LCV’s in 2008 helped Peugeot grow its market share even in 2009’s falling market. This is of course a highly profitable segment for the group and, as we argued above, we believe that despite a gradual erosion of market share from 2009’s peak, growth in the segment as a whole will provide an EBIT boost of €230mn to Peugeot over the next three years.

Figure 181: Peugeot to have one of the youngest and most diverse product portfolios in the sector

Segment 2008 2009 2010 2011 2012

A&B C3 Picasso Q1

C3 Q4 DS3 Q1

208

C1

C 308 Q2 3008 Q1 5008 Q4 RCZ coupe Q1

C4 Q1 DS4 Q3 C4 Picasso

D 4007 Q3

C5 Q1 408 Q2

408 Coupe

DS5 Q4 C5

LCV

Nemo/Bipper

Berlingo 2Q Partner Q2 Jumpy

Source: Company data, JD Power, Trade press, Barclays Capital


8 December 2009 111

Strength in fuel efficient engine technologies As well as expanding its model range, Peugeot is also devoting a great deal of attention to the development of fuel efficient technologies such as diesel hybrids and EVs. Despite our concerns for share erosion in the A&B segments in 2010E due to scrappage pull-back, we still expect the long-term trend towards CO2 friendly vehicles to continue and thus Peugeot’s superiority in this area should set it in good stead. The company’s first EV is to be a version of an existing Mitsubishi product, the i-Miev, and is due in 2010. Longer term, its hybrid diesel technology is expected to launch in 2011, coming first on the Peugeot 3008 HYbrid4 and then the Citroen DS5 HYbrid4, with a Plug-In HYbrid4 diesel to follow in 2012. An alliance with BMW on engines further highlights the company’s lead in this area.

Faurecia – a turnaround story but well understood by investors Faurecia’s performance has long been a drag on its parent company. Currently 71% owned by PSA, Faurecia has been loss-making since 2006 and was hit hard by the severe OEM production cuts in 1H09. However, the company’s management are highly focused on restructuring and efforts in North America in particular have already begun to pay off. There is still much to be done in the short term and we only forecast a 1% EBIT margin from Faurecia in 2010E but our longer-term expectations are based on our belief that the supplier can achieve margins much closer to competitor averages in each of its divisions.

Figure 182: Potential for strong recovery at Faurecia based on competitive margin benchmarking

Business segment Benchmark EBIT margins (%) Global competitors Comment

2010 Midterm

Seating 5 - 6 6 - 7 LEA, JCI, MGA Concentrated oligopoly Interiors 1-2 4 - 5 JCI, numerous others Fragmented business historically, becoming

somewhat more concentrated as suppliers exit Exhaust 4 - 5 6 - 7 TEN, Eberspracher Becoming more concentrated with Faurecia

acquisition of EMCON; solid growth opportunities as emissions control requirements for passenger and commercial vehicles become more stringent

Front-end modules 2 - 3 5 - 6 Magna/Decoma, Plastal, Peguform and numerous others

Highly fragmented


Figure 183: PSA no. 1 position in LCV market 10E to boost EBIT

Figure 184: LCV market set to recover 180bp from 2009’s low

PSA25%

Renault-Nissan17%

VW Group15%

Fiat 14%

Ford 11%

Daimler9%

Opel 6%

Other3%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2006 2008 2010 2012 201415.0%

20.0%

25.0%

30.0%


PSA share of WE van market

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2006 2008 2010 2012 201415.0%

20.0%

25.0%

30.0%


PSA share of WE van market

Source: CSM, company data and Barclays Capital Source: CSM and Barclays Capital


8 December 2009 112

We therefore forecast that the company can reach a 5% group margin by 2012E - at the top end of management’s 4.5-5% target but just behind midterm peer benchmark margin, thus boosting its parent company EBIT by an estimated €850mn. The recent EMCON acquisition should further boost the company in the fast-growing exhaust systems segment. Although the market is currently looking for only a 2.5% margin by 2011E (no 2012E consensus data is yet available), we believe that the French investment community already credit a great deal of longer-term restructuring success to the company, and therefore see less upside for the PSA shareholder.

There has been much speculation in the press and the investment community for a long while surrounding the likelihood of a Faurecia disposal. Although the recently announced EMCON deal will see Peugeot’s stake in the parts supplier diluted from 71% to 57%, with the execution of the OCEANE convertible bond taking the holding down to 51%, this still will not be low enough to allow PSA to deconsolidate Faurecia’s €1.5bn of debt (and thus aid Peugeot in regaining its investment grade debt rating). Change of ownership covenants currently prohibit PSA’s ownership from falling below 40% and it seems unlikely that a buyer will be found for Faurecia until the company’s turnaround is closer to completion. However, the PSA share has historically rebounded strongly on any news regarding an eventual disposal, hence we are wary of underweighting the share whilst M&A speculation abounds.

Figure 185: Consensus earnings estimates have moved into the black for 2011E

Figure 186: Brokers have grown significantly more optimistic on the Faurecia share in 2H09

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8 December 2009 113

Peugeot’s 2016 convertible: Recommended for investors seeking defensive exposure

The convertible asset class has attracted substantial interest this year, rebounding sharply from its late-2008 trauma. Resurgent new issuance, particularly in Europe, has seen many companies raise convertible funds, including Peugeot and Faurecia.

For equity investors, many convertibles offer exposure (delta) to the underlying equity, but with the defensive characteristics of downside protection (delta is higher on the upside than on the downside), senior status, an income advantage and strong takeover and dividend protection features. We believe that switching into the Peugeot convertible makes sense for relatively defensive investors who wish to step up in the capital structure and reap a significant income pick-up over the stock.

We estimate that Peugeot’s 2016 convertible currently has a c.64% delta to the stock price and a c.3.6% income pick-up over the stock (Figure 187). At our fundamental equity analysts’ stock price target, we estimate that the convertible’s valuation would rise 3.8% from its current level (target bond price versus current bond price). This is below the 7.5% rise in the stock. Adding the 3.6% pa income advantage, however, makes the convertible’s return more competitive. The convertible is generally less liquid than the stock, although the €575mn bond has traded actively since launch in June 2009.

Lastly, we view the convertible’s valuation as fair relative to the equity derivative (options) market and relative to other comparable convertibles. As such, the investment rationale is not based on cheapness or richness per se, but rather, its defensive profile compared to cash equity, together with its income advantage and seniority.

Figure 187: Peugeot 4.45% 2016 convertible bond details

Bond ISIN Bond

currency Current

bond price Parity Amount out

(mn) Yield to

maturity Running

yield

FR0010773226 EUR €31.33 €24.18 575 0.60% 3.62%

Note: As of 4 December 2009. Source: Barclays Capital

Credit perspective Barclays Capital credit analysts currently rate Peugeot Market Weight. While they expect credit metrics to improve through 2010, they believe Peugeot is at risk of a downgrade to mid BB by S&P and view Peugeot more at risk of material cash burn than Renault in 2010. However, following significant bond issuance this year and government funding, they believe Peugeot has significantly improved its liquidity position.

Equity rating

We are initiating coverage of Peugeot with a 2-Equal Weight rating. Despite our confidence in Peugeot’s product strategy, we remain more cautious than the market on the demand side of the equation for the overall European market in 2010E. We are concerned that the company’s lack of scale both on a global basis but also on a platform-by-platform basis exposes the company to significant risks. We also believe that the market is already well versed in Peugeot’s upcoming product line-up and is already over-crediting the company’s

Luke Olsen +44 (0)20 7773 8310


Angus Allison

+44 (0)20 7773 5379 [email protected]


Heather Beattie, CFA +44 (0)20 7773 5859


Stella Cridge

+44 (0)20 3134 9618 [email protected]


Conversion price Current

share priceTarget

share priceTarget bond

price Dividend

yield Income

advantage Convertible

delta

€25.10 €24.18 €26.00 €32.53 0.00% 3.62% 64%

We believe the market is overly optimistic on PSA’s potential for

top-line growth and for retention of future cost savings


8 December 2009 114

revenue growth potential by 2012E. We credit the company with only €2.1bn of its targeted €3.3bn in cost savings by 2012E. Likewise, we think that the Faurecia recovery story, though significant, is already well understood by the market. We hesitate to underweight Peugeot due to its superior product and when any further news on a potential Faurecia disposal would provide upside potential for PSA but the company’s lack of scale and the market’s over-confidence in estimates steer us away from an overweight rating. We are therefore initiating coverage with 2-Equal Weight rating and a €26 price target.

Valuation methodology We value the PSA share using a SotP methodology but also use historical and peer average EV/EBITDA multiples and take a blended average of the two methodologies:

SotP

Using a sum-of-the-parts valuation we arrive at a value of €28/share for Peugeot, implying 12% upside potential to its current market price. We base our calculation on a blended average of peer EV/sales and EV/EBITDA multiples for the core Autos business and bring in Finance companies, GEFCO and Faurecia at historical average multiples. We apply a 5% discount to the NAV in line with the average discount that the market has historically applied when using the SotP methodology.

Figure 188: Peugeot SotP implies just 12% upside to the current share price, driving our 2-Equal Weight rating

NAV, PSA €mn € per share Remarks

1) PSA Auto @ EV/sales multiple 6,888 30 15% 2011E Industrial EV/sales (in line with Renault)

2) PSA Auto @ EV/EBITDA multiple 5,616 25 2.0x 2011E Industrial EV/EBITDA (in line with Renault)

Peugeot Auto average 6,252 28

Banque PSA Finance (0.8x equity) 3,141 14 0.8x book value

Gefco @ EV/sales multiple 650 3 20% 2011E EV/sales

Faurecia @ EV/sales multiple 2,078 9 15% 2011E EV/sales

Group EV 12,121 53

Net debt -4,267 -19 FY10E BS date

Pension underfunding -819 -4 FY10E BS date

Minorities -329 -1 FY10E BS date

SOTP (base assumption) 6,706 30

TP applying holding discount 6,304 28 5% discount


Group EV/EBITDA

Historically PSA has traded at an 8-year average of 2.4x EV/EBITDA at a group level (vs 6x at RNO and 2.7x for the sector as a whole). Our slightly below consensus EBITDA estimates put PSA at 2.5x at current share price in 2010E, just ahead of its historical average. We believe that the company should trade closer to its historical level of 2.4x, which would imply a share price of €23.


8 December 2009 115

Figure 189: PSA historical EV/EBITDA implies a 2.4x multiple is realistic to value the group

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2000 2001 2002 2003 2004 2005 2006 2007 2008

Historical average Adjusted EV/EBITDA



8 December 2009 116

A blended average of both these valuation metrics leads us to set a €26 price target for the share.

Figure 190: PSA key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E


Industrial EV/sales (%) 17 17 13 11 15 10 7 Industrial EV/EBITDA 2.7x 2.3x 2.6x 3.0x 2.5x 1.2x 0.8x Industrial EV/EBIT 17.8x 8.2x na (5.1x) (37.6x) 4.4x 2.2x P/E 59.3x 14.6x (18.5x) (3.8x) (12.6x) 8.3x 4.9x FCF yield (%) 1.4 17.2 -49.4 -3.6 -40.8 25.1 25.3 Price/sales (%) 20 23 12 12 12 11 11 Price/book 0.8x 0.9x 0.5x 0.4x 0.5x 0.4x 0.4x Dividend yield (%) 2.8 2.7 0.0 0.0 0.0 4.2 4.2 Valuation multiples at €26 price target

Industrial EV/sales (%) 17 17 13 12 16 11 8 Industrial EV/EBITDA 2.2x 2.0x 1.9x 2.3x 2.5x 1.3x 0.9x

Industrial EV/EBIT 17.8x 8.2x na (5.6x) (40.3x) 4.9x 2.5x

P/E 59.3x 14.6x (18.5x) (4.1x) (13.7x) 9.0x 5.3x

FCF yield (%) 1.4 17.2 -49.4 -3.3 -37.5 23.1 23.3 Price/sales (%) 20 23 12 13 13 12 12 Price/book 0.8x 0.9x 0.5x 0.5x 0.5x 0.5x 0.4x

Dividend yield (%) 2.8 2.7 0.0 0.0 0.0 3.8 3.8


Risks to price target Downside risks to our price target are as follows:

Macroeconomic risks - macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

Liquidity risk – current high gearing levels and lack of investment grade credit rating expose the share to balance sheet risk, especially were the Peugeot to finance any future alliance with Mitsubishi Motors with debt

M&A risk – if PSA were to embark on any further strategic alliances or seek to restructure its holding in Faurecia, this could provide further upside to the share and cause it to exceed our current price target.


8 December 2009 117

Figure 191: PSA Group income statement, 2006-2012E

December year-end (€mn) 2006 2007 2008 2009E 2010E 2011E 2012E

Net revenues 56,594 60,613 54,356 47,313 47,903 51,135 53,115

Cost of sales (45,882) (48,435) (44,920) (39,700) (39,534) (40,942) (42,069)

Gross profit 10,712 12,178 9,436 7,613 8,370 10,192 11,046

Memo: gross margin (% of sales) 18.9% 20.1% 17.4% 16.1% 17.5% 19.9% 20.8%

SG&A (7,576) (8,354) (6,841) (6,433) (6,432) (6,803) (7,062)

Research & development (2,017) (2,072) (2,045) (1,861) (1,745) (1,866) (1,940)

Clean EBIT 1,119 1,752 550 (681) 193 1,523 2,044

Memo: clean EBIT margin (% of sales) 2.0% 2.9% 1.0% -1.4% 0.4% 3.0% 3.8%

Non-recurring income and (expenses) (809) (632) (917) (700) (150) (140) 0

Reported operating income 310 1,120 (367) (1,381) 43 1,383 2,044

Financial income/expense & other (105) (40) (286) (400) (450) (350) (350)

Pre-tax income 205 1,080 (653) (1,781) (407) 1,033 1,694

Income tax (156) (302) 96 415 35 (321) (526)

Memo: tax rate 76% 28% 15% 23% 9% 31% 31%

Companies at equity 20 48 57 40 40 40 40

Net before minority interest 69 826 (500) (1,326) (332) 752 1,208

Minority Interest (114) (59) (157) (100) (100) (100) (100)

Group interest 183 885 (343) (1,426) (432) 652 1,108

No of shares (average) 228.7 228.3 227.6 226.9 226.9 226.9 226.9

EPS 0.80 3.88 (1.51) (6.28) (1.90) 2.87 4.88

DPS 1.35 1.50 0.00 0.00 0.00 1.00 1.00

PSA segmental revenue:

Automobile revenues 44,566 45,519 41,643 36,819 36,084 38,822 40,376

Faurecia revenues 11,649 12,661 12,011 9,369 10,493 11,542 11,831

GEFCO revenues 3,245 3,554 3,536 3,006 3,096 3,251 3,348

Industrial revenues 53,789 57,132 52,705 45,393 45,923 49,115 51,055

Banque PSA Finance revenues 1,761 1,999 2,088 1,920 1,980 2,020 2,060

Total Group revenues 56,594 60,613 54,356 47,313 47,903 51,135 53,115

PSA segmental EBIT:

Automobile EBIT 267 858 (225) (795) (375) 575 895

Faurecia EBIT 69 121 91 (281) 105 404 592

GEFCO EBIT 151 155 127 75 93 114 117

Industrial EBIT 515 1,144 (7) (1,001) (177) 1,093 1,604

Banque PSA Finance EBIT 604 608 557 320 370 430 440

Total Group EBIT 1,119 1,752 550 (681) 193 1,523 2,044

PSA segmental EBIT margin %

Automobile EBIT % 0.6% 1.9% -0.5% -2.2% -1.0% 1.5% 2.2%

Faurecia EBIT % 0.6% 1.0% 0.8% -3.0% 1.0% 3.5% 5.0%

GEFCO EBIT % 4.7% 4.4% 3.6% 2.5% 3.0% 3.5% 3.5%

Industrial EBIT % 1.0% 2.0% 0.0% -2.2% -0.4% 2.2% 3.1%

Banque PSA Finance EBIT % 34.3% 30.4% 26.7% 16.7% 18.7% 21.3% 21.4%

Total Group EBIT % 2.0% 2.9% 1.0% -1.4% 0.4% 3.0% 3.8%



8 December 2009 118

Figure 192: PSA Industrial and Group balance sheet, 2006-2012E

December year-end (€mn) 2006 2007 2008 2009E 2010E 2011E 2012E Industrial assets:

Goodwill 1,547 1,488 1,237 1,237 1,237 1,237 1,237

Other intangibles 3,947 3,885 4,061 4,560 4,652 4,750 4,853

Property, plant and equipment 15,221 14,652 14,064 13,270 12,894 12,457 11,990

Other non current financial assets 1,321 1,121 848 848 848 848 848

Deferred tax & other 595 554 620 620 620 620 620

Investments in associates/non-consolidated co.s 681 772 780 820 860 900 940

Total Industrial fixed assets 23,312 22,472 21,610 21,355 21,111 20,812 20,488

Inventories 6,826 6,913 7,757 6,026 6,836 6,538 6,719

Accounts receivable 3,043 2,857 2,001 2,114 2,391 2,018 2,098

Tax & Other receivables/assets 1,929 1,951 2,086 2,086 2086 2086 2086

Marketable securities 1,132 1,483 515 515 515 515 515

Cash 6,339 5,185 2,040 7,224 5,249 6,623 7,870

Total Industrial current assets 19,269 18,389 14,399 17,965 17,077 17,780 19,289

Total Industrial assets 42,581 40,861 36,009 39,321 38,188 38,592 39,776

Total Finance Co assets 27,191 28,768 26,381 24,300 25,000 25,500 26,000


Total Industrial LT liabilities 10,121 9,978 9,481 14,051 14,051 14,051 14,051

Total Industrial current liabilities 21,006 19,222 16,170 16,451 16,175 16,619 16,973

Total industrial liabilities 31,127 29,200 25,651 30,502 30,226 30,670 31,024

Total Finance Co liabilities 24,539 25,874 23,462 20,899 21,074 21,009 21,359

Group shareholders' equity 13,718 14,245 13,143 11,990 11,559 11,984 12,864


Shareholders' funds 14,106 14,555 13,277 12,219 11,888 12,413 13,393

TOTAL GROUP LIABILITIES & S'HOLDERS EQUITY 69,094 68,975 61,720 62,971 62,538 63,442 65,126

Balance sheet analysis & drivers:

Capital employed 19,418 18,840 20,897 19,477 21,099 20,398 20,249

Net working capital (612) (830) 1,330 (317) 1,023 57 82

Working capital / Sales -1% -1% 3% -1% 2% 0% 0%

Net Industrial cash (debt) 116 1,404 (2,906) (2,292) (4,267) (2,893) (1,646)

Gearing -1% -10% 22% 19% 36% 23% 12%



8 December 2009 119

Figure 193: PSA Industrial and Group cash flow, 2006-2012E

December year-end €mn 2006 2007 2008 2009E 2010E 2011E 2012E

Industrial cash flow:

Net Income (329) 405 (851) (1,536) (582) 462 918

Depreciation and amortisation 3,686 3,559 3,664 3,405 2,985 2,947 3,063

Non-current provisions (148) (227) (105) 0 0 0 0

Deferred tax (139) (114) (455) (455) (455) (455) 0

(Gains) losses on disposals (54) (94) 124 0 0 0 0

Share in equity co's (net of dividends) (17) (46) (37) 0 0 0 100

Revaluation adjustments (IFRS) 11 32 26 0 0 0 0

Gross cash flow 3,010 3,515 2,366 1,414 1,948 2,954 4,081

(Increase)/decrease in inventories 63 (87) (1,076) 1,731 (810) 298 (181)

(Increase)/decrease in receivables 54 186 804 (113) (276) 372 (80)

Increase/(decrease) in payables 241 119 (2,015) 29 (254) 296 236

Movement in provisions/other 66 702 (637) 252 (22) 148 118

INDUSTRIAL OPERATING CASH FLOW 3,434 4,435 (558) 3,313 586 4,068 4,174

Capital expenditure (2,520) (1,924) (2,080) (1,952) (1,837) (1,719) (1,787)

Capitalisation of R&D (937) (789) (1,069) (1,258) (964) (989) (1,012)

Proceeds from disposals 160 156 78 100 100 100 100

Investment in companies (19) (7) (2) 0 0 0 0

Investment in shares (1) 11 (25) 0 0 0 0

Other (155) (280) (79) 0 0 0 0

INDUSTRIAL CASH FLOW FROM INVESTING (3,472) (2,833) (3,177) (3,110) (2,701) (2,608) (2,699)

Group dividend (309) (309) (342) 0 0 (227) (227)

Minority dividend 155 146 151 138 140 140 0

Equity issued/(redeemed) (39) (23) (43) 0 0 0

ST Debt issued/(redeemed)

LT Debt issued/(redeemed) 205 (559) 929 4570 0 0 0

Other 273

INDUSTRIAL CASH FLOW FROM FINANCING 12 (745) 695 4,981 140 (87) (227)

NET CHANGE IN INDUSTRIAL CASH 19 835 (3,099) 5,184 (1,975) 1,374 1,247

Operating cash from Finance Co's 210 512 590 (300) 0 0 0

Investing cash from Finance Co's (34) (20) (22) 0 0 0 0

Finance Co minority dividends (193) (157) (167) (143) (140) (140) 0

FX & eliminations (60) 131 (5) 0 0 0 0

NET CHANGE IN GROUP CASH (58) 1,301 (2,703) 4,741 (2,115) 1,234 1,247

PSA cash flow analysis & drivers:

Total movement in WC 424 920 (2,924) 1,899 (1,362) 1,114 93

Industrial FCF (23) 1,722 (3,707) 103 (2,215) 1,360 1,374

Group FCF 153 2,214 (3,139) (197) (2,215) 1,360 1,374

Industrial depn & amort / sales, % 6.9% 6.2% 7.0% 7.5% 6.5% 6.0% 6.0%

Industrial capex / sales, % 4.7% 3.4% 3.9% 4.3% 4.0% 3.5% 3.5%



8 December 2009 120

Figure 194: PSA revenue mix by division YTD 09 Figure 195: PSA geographical revenue mix, YTD 09

Faurecia20%

GEFCO6%

Autos70%

Banque Finance

4%

W Europe76%

C&E Europe8%

Lat Am7%

ROW9%

Source Company data, Barclays Capital Source Company data, Barclays Capital

Figure 196: Peugeot WE unit sales by model, YTD09A Figure 197: Citroen WE unit sales by model, YTD09A

206 / 20742%

307 / 30819%

30082%

405 (kit)16%

Boxer & Bipper

3%Partner

7%

Other1%

406+ 4072%

Expert1%

106 / 1077%

C1

10% C2 / Saxo4%

C3 (incl. Pluriel)

17%

C3 Picasso6%

ZX6%

C4 / Xsara29%

C-Crosser1%

Berlingo13%

C5 / Xantia8%

LCV + Other6%


Figure 198: PSA EBIT mix by division, 2011E Figure 199: PSA EBIT margin %, 2002A-2012E

Automobile EBIT38%

Faurecia EBIT27%

GEFCO EBIT7%

Banque PSA Finance

EBIT28%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2000 2002 2004 2006 2008 2010E 2012E

Autos EBIT Margin % PSA Group EBIT Margin %



8 December 2009 121

PORSCHE – MERGER BENEFITS MAY NOT FLOW TO PREF HOLDERS: 2-EQUAL WEIGHT

We are initiating coverage of Porsche with a 2-Equal Weight rating and a €55 price target. While Porsche’s near-term prospects as a sports car manufacturer are strong in the face of a challenging market, the real value of Porsche’s pref shares lie in the current 51% holding of VW shares and their eventual conversion into VW NewCo shares (likely prefs). While we maintain a positive stance toward VW prefs (with a 1-Overweight and €85 target), we believe that public shareholders in both firms face transactional risk around the future fundraising and eventual merger ratios. With VW we believe that the ultimate earnings power, against the near-term low valuation in light of Qatari share sales, offers better protection against the vagaries of offering dilution and exchange ratios than do the Porsche prefs.

Figure 200: Porsche – headline data & valuation multiples (at current share price), 2008-11E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 7,466 6,260 7,094 8,362 8,912

Adjusted/clean EBIT 876 676 760 977 1,370

EBIT margin (%) 11.3 10.3 10.7 11.7 15.4

BC EPS € 35.95 -14.29 1.47 4.74 7.61

Consensus EPS € 35.95 -14.45 2.73 6.81 7.76



P/E ratio (%) 2.8x (6.6) (53.4) (84.2) 263.3x


2-Equal Weight, €55 price target We are initiating coverage of Porsche with a 2-Equal Weight rating and a €55 price target, reflecting the uncertainties and risks in the next 16-18 months. Overall, while most of the value of Porsche is in its VW stake, and we are positive on VW prefs, we see several transactional risks to Porsche pref holders from future fund raising and merger valuations that lead us to prefer VW pref shares as our vehicle for capturing the future value of VW. We base our price target for the Porsche’s preference shares using an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples (for further details please see the valuation section).


Positives:

Strong underlying operating performance in difficult year

Modular strategy to drive additional cost savings while enhancing product differentiation

Continued dominance of German market provides buffer against weak post-scrappage pricing environment

Porsche merger valuation mechanics not as impactful on pref value as market believes

PSHG_p.DE / PAH3 GY




Price (04-Dec-2009) €47.51



8 December 2009 122

Risks:

Continued selling pressure as Qatar liquidates remaining pref shares

Rights issue in 2010 creates additional supply and selling pressure

Clarity on Porsche merger pricing not likely until 2011

European pricing war undermines profit recovery and stalls margin recovery

Earnings power of the sports car company remains strong While transparency into Porsche results ex Volkswagen and option losses is limited (and likely to become more limited as Porsche SE moves to equity income for both VW AG and Porsche AG), underlying results of the sports car company within the financial speculation company appear strong. Porsche disclosed a 10.3% core operating margin for 2008/2009, indicating roughly €675mn of “clean” operating earnings for its sports car operations. While about €200mn below the €876mn earned in 2008, revenue fell by a likely €1.2bn – indicating incremental margins of 17%.

The strong performance was likely driven by a richening mix, with the relative strength of the 911 (up from 32% to 36% of sales) and the Cayenne (steady at 46% of sales) offsetting the volume decline in the lower margin Boxster/Cayman.

Figure 201: Porsche key operating metrics

€mn 2004/05 2005/06 2006/07 2007/08 2008/09E 2009/10E 2010/11E 2011/12E

Unit sales (units):

Boxster/Cayman 18,009 27,906 26,146 21,747 13,140 16,000 18,000 18,900

911 27,826 34,386 37,415 31,423 27,070 30,000 32,000 33,920

Cayenne 41,884 34,134 33,943 45,478 34,265 26,000 35,000 38,500

Panamera 0 0 0 0 763 17,000 22,000 23,100

Total unit sales 88,379 96,794 97,517 98,652 75,238 89,000 107,000 114,420

Total production 90,954 102,602 101,844 105,162 76,739 90,800 109,200 116,800

Average selling price (€) 59,723 62,568 63,724 63,172 69,911 68,000 68,000 68,000

Revenue 6,256 7,123 7,368 7,466 6,260 7,094 8,362 8,912

Total operating perf. 6,337 6,326 7,296 7,530 7,778 6,560 7,294 8,412

Adjusted EBIT 1,204 1,571 1,146 876 676 760 977 1,370

Adj. EBIT margin 19.0% 21.5% 15.2% 11.3% 10.3% 10.7% 11.7% 15.4%

Incremental margin 77% 42% -173% -274% 17% 10% 17% 71%

Incremental EBIT per unit € 7,204 € 43,539 -€ 587,733 -€ 237,889 € 8,541 € 6,115 € 12,058 € 52,930



8 December 2009 123

Figure 202: Stronger mix likely to drive higher earnings in 08/09E

27% 22% 17%

38%32% 36%

35%46% 46%

1%

0%

20%

40%

60%

80%

100%

2006/07 2007/08 2008/09E

Boxster/Cayman 911 Cayenne Panamera

27% 22% 17%

38%32% 36%

35%46% 46%

1%

0%

20%

40%

60%

80%

100%

2006/07 2007/08 2008/09E

Boxster/Cayman 911 Cayenne Panamera


Going forward, we are looking for 14,000 unit growth in 2009/10, driven largely by the Panamera, with margins reaching 10.7%. In 2010/11 (the likely time period for starting the IDS valuation), units could advance by another 18,000, driven by broader economic recovery, and with incremental margins of 17% EBIT of €977mn. The benefits of the VW modularity would likely not begin until 2012, when margins could expand to 15%, closer to the 2001-07 average of 16.9%. As this margin expansion (incremental margins of over 70%) is based on VW contributions, it is not clear how much of that margin expansion would be shared with Porsche pref holders.

Net debt to be worked off by set of transactions but risk remains

While the sports car operating side of Porsche handled the curves of 2009 ably, the financial side of the story was less heartening. Porsche disclosed that its liquidity situation was “critical” as of June 2009, alleviated somewhat when it was able to recapture use of €1.4bn of cash pledged as collateral for its derivatives on VW shares. With €11.4bn of net debt, and €13bn total (with pensions and hybrids) Porsche can (by design) work off most of its net debt if the planned series of transactions consummate. If not, as the annual report warns, as underscored by the accountant’s letter

If the steps involved in the merger of Porsche Automobil Holding SE and Volkswagen AG and thus the debt relief of Porsche Automobil Holding SE do not take place as planned, this could once again lead Porsche Automobil Holding SE into a critical liquidity situation by the end of 2009 which could put the ability of the company and group to continue as a going concern at risk. (Source: Porsche Annual Report 2008/09, page 243)

VW fundraising and Porsche transaction timeline However, the transaction structure has been designed to alleviate Porsche’s debt burden. In this quarter, we expect VW to finalize its purchase of 49% of Porsche AG for €3.9bn. In addition, by mid 2010, the market will be asked to absorb up to roughly 90mn additional VW pref shares – up to 25mn from Qatar Holding LLC (whose lock-up period expires on 31 December 2009, although it is not clear whether Qatar holds actual shares or options shares, and, if options, if deliverable in physical delivery of shares) and about 65mn from a


8 December 2009 124

VW pref issue in 1H10 (assuming €4bn raised at €60/share). The net result is to almost double the ‘publically held’ pref share count from the 55mn outstanding prior to Qatar’s initial sale to about 170mn – leading to, in our view, much of the recent weakness in VW prefs.

Figure 203: Merger timeline

Date Event

2009

3 December 2009 Announcement of DAX official ranking as of 30 Nov

3 December 2009 VW EGM gave authorisation for VW pref share issuance

18 December 2009 Qatar option expiry on VW ords

31 December 2009 Expiry of Qatar lock-up period on VW prefs

by 31 December 2009 Purchase of 49% of Porsche AG by VW for €3.9bn

2010

11 March 2010 VW FY09 results

sometime in 1H10 Potential VW pref issue (est €4bn, window likely 11 Mar-15 May)

2011

sometime in 1H11 VW purchases Porsche Holding Salzburg for €3.55 EV

sometime in 1H11 Porsche SE capital increase (est. €5bn)

sometime in 2011 Porsche SE merges into VW AG


We expect the VW pref issue at some point following the 2009 results announcement on 11 March 2010.

Before the merger, VW is to purchase two assets – 49% of Porsche SE (for €3.9bn, paid to Porsche AG) and Porsche Holdings Salzburg (for €3.55bn, paid to family shareholders of the auto dealer). Porsche would also pursue a capital increase of about €5bn, likely timed after Porsche/Piech family members receive the proceeds from the Salzburg sale. After the capital increase, Porsche SE (which at that times owns half of Porsche AG and its VW ord shares but has largely paid down its debt), merges into VW AG, with Porsche ord shareholders largely receiving VW ords and Porsche prefs would get VW prefs (although merger details could vary).

Transaction sequence aimed at stepping down net debt However, the transaction structure has been designed to alleviate Porsche’s debt burden, beginning with the initial purchase of 49% of Porsche SE.

Figure 204: Porsche merger dynamics to reduce net debt

€mn

Transaction impact Running total

Porsche net debt as of Nov. 2009 -11.4

Sale of Porsche SE (4Q09) 3.9 -7.5

Porsche capital increase (1H11) 5.0 -2.5

Est. operating cash flow 09/10 and 1H11 0.8 -1.8

Est. net debt at time of merger -1.8

(inc. hybrids and pensions) -3.5



8 December 2009 125

Porsche valuation driven by merger exchange formula

As Porsche is basically a holding shell for Volkswagen shares, valuation of Porsche must be in context of a future merger with VW. As we review these steps, we become convinced that VW pref holders face relatively little risk from the future share offerings and mergers, while the Porsche pref holders face greater downside risk around terms of the Porsche fund raising and merger valuations.

In terms of risks to valuation from these transactions, we start with the value the core operating businesses of both VW and Porsche (as this will likely form the basis for the future IDW S-1 valuation), and add in ‘external’ affiliates (ie, MAN) and subtract net debt. For purposes of this exercise, we have chosen a low adjusted EV/EBITDA multiple for VW (2.5 x vs historical average of 3.5x) for the industrial business. For Porsche, we assume 6.0x for a gross operating enterprise value of €10bn (note that this is somewhat below the €12.4bn VW pegged the value of Porsche SE at; again, we have chosen to be conservative as this would imply that VW ‘overpaid’ for Porsche SE).

Step 1: Value of stand-alone operating firms

Adjusting for VW's cash balance, and including the value of financial services and MAN leads to an enterprise value of €44bn for VW, or €95 per pref share (at a 20% discount), before giving effect to VW’s purchases of Porsche-related assets. While Porsche operating business is strong, even at a 6x multiple for the SE earnings, Porsche would have negative value (but for the VW shares).

Figure 205: Value of VW & Porsche operating businesses

€mn VW Porsche

Starting point – operating businesses and 'external' affiliates

2011 EBTIDA 11,469 1,765

EV/EBITDA multiple 2.5x 6.0x

Core auto operations 28,671 10,590

Financial services 9,372 239

"External" associates -2,396

Gross value of operating firm and external affiliates 35,647 10,828

less debt

Net debt (cash) -18,840 11,400

Minorities 1,905

Hybrid liabilities 1,020

Pension (after tax) 8,495 -431

Net value of firm before intracompany ownership 44,086 -1,161

per share € 108 -€ 7

per ord € 119

per pref € 95

at discount of 20



8 December 2009 126

Step 2: Giving effect to VW purchase of Porsche related assets

One investor concern is that VW, in an attempt to gain Porsche family buy-in to the merger, agreed to overpay for the initial stake in Porsche SE (which provides cash to pay down Porsche net debt) and for control of Porsche Holding Salzburg (which will provide cash to the families to use to subscribe to Porsche fund raising). Even assuming VW overpaid for Porsche SE by €1.25bn (as the €12.4bn paid for a 49% equity stake would imply a EV/EBITDA of 7.6x vs our assumption of 6.0x) and by Salzburg by 1.5bn (with no public financials we have arbitrarily assumed an overpayment), pref value per share would still be €89.

Also note that at this point, Porsche as an operating company has negative value, with more than 100% of the value of Porsche shares attributable to its holdings in VW. With the VW shares included (assuming a €102 per share, near our target of €100 for the VW ords), Porsche would have an indicative value of €86 per share at this point.

Figure 206: VW purchase of Porsche assets

€mn VW Porsche



Plus intra-group transactions

VW minority in Porsche AG:

Value of equity business interest 3,038 -3,038

Cash received/(paid) -3,900 3,900

Debt (assumed)/shed

Memo: value creation (dilution) -862 862

VW purchase of Porsche Salzburg

Value of business interest 2,000

Cash received/(paid) -3,500

Memo: value creation (dilution) -1,500

Value after sales to VW (ex cross-holdings) 41,724 -298 Value of Porsche AG stake in VW 15,325

Net value of firms before fund raise 41,724 15,027

per share € 102 € 86

per ord € 112

per pref € 90 at discount of 20



8 December 2009 127

Step 3: Giving effect to potential dilution from fund raising

While we believe an offering below the current share price would be dilutive to both firms, our VW price target of €85 can withstand dilution. Porsche, on the other hand, with the stated intention of raising about €5bn (and, given the debt walk down, the need to raise that amount), is more vulnerable to dilution. Moreover, as the offer is likely to be tilted toward the family and other strategic ord purchasers, pref shareholders run some risk of ill treatment. Were €5bn of shares offered at €40, the shares would be diluted down from €76 to €62, which is near our price target of €55, even before adding a discount for transaction risk.

Figure 207: Effects of fund raising

€mn VW Porsche

Value after sales to VW (ex cross-holdings) 41,724 -298

Fund raising 4,000 5,000

Shares issued 80 125

Price per share € 50 € 40

New share count 488 300

Value of firms after fund raise (ex cross-holdings) 45,724 4,702Value of Porsche AG stake in VW 14,041

Net value of firms after fund raise 45,724 18,743

per share € 94 € 62 per ord € 103

per pref € 82

at discount of 20



8 December 2009 128

Step 4: Potential risk from relative IDW S1 relative valuations and pref/ord exchange ratios

Finally, while investors are concerned that VW pref shareholders will wind up with less of the merged company than what they could consider their fair share, Porsche investors may have similar valuation risk were, for example, merger synergies allocated more to VW. At our base case valuations, Porsche shareholders would get 37% of the economic value of the merged entity and VW shareholders 63% (roughly in line with ingoing ownership). However, even at that point pref holders could face some risk around the division on merger value between Porsche ords and prefs – based on discussions with the companies, we understand that a merger of a company with ords and prefs into another company with ords and prefs is relatively unchartered territory in German corporate law.

Figure 208: Merger allocation options

VW Porsche

Who brought what to the table:

VW shareholders ex Porsche 31,683

Porsche shareholders

Core business 4,702

VW stake 14,041

Total 31,683 18,743 % of newco 63% 37%

Per share € 94 € 62

per ord € 103

per pref € 82

at discount of 20%

What if "unfair"



Core business 10,400

VW stake 12,291

Total 27,734 22,692 % of newco 55% 45%

Per share € 82 € 76

per ord € 90

per pref € 72

at discount of 20


Even assuming, however, that Porsche shareholders get 45% of the combined firm, and that VW is arbitrarily undervalued, and Porsche SE is overvalued by a factor of 3x, would create only about €76 of value per Porsche share – making the upside of a merger that tilts towards Porsche not worth the risks were prefs diluted more in either the fundraising or the merger process.

Rating We are initiating coverage of Porsche with a 2-Equal Weight rating and a €55 price target, reflecting the uncertainties and risks in the next 16-18 months.


8 December 2009 129

Valuation methodology We value the Porsche preference share based on an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples:

EV/sales

Porsche prefs have historically traded at an eight-year average of 100% EV/sales, although rose to 200% as sales dipped in 2009. At current market price the shares are only trading at 27% 2010E EV/sales on our estimates.

Figure 209: Slightly above consensus revenue & earnings estimates

2010E Barclays Capital Consensus Variance

Revenue (€mn) 7,094 7,332 -3.2%

EPS (€) 1.47 2.73 -46.2%


We believe given the fundraising and merger risks that Porsche should trade at 50% EV/sales, closer to the peer historical average of 43%, and implying a value of €60/share.

Figure 210: Porsche EV/sales metrics

0%

50%

100%

150%

200%

250%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

EV/Sales

0%

50%

100%

150%

200%

250%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

EV/Sales


EV/EBITDA

Historically Porsche has traded at an average of 4.6x EV to EBITDA during 2001-07 (before the extensive distortion of its options earnings) – vs 3.4x for the sector as a whole). Looking out to 2011E, when we expect the merger to finalize, at the current market price the share is trading at only 1.3x. Recognizing some of the risks inherent in the merger and future dilution, we conservatively believe that the company should trade at 3.1x, from which we derive a price of €50/share.

An average of both these valuation metrics leads us to set a €55 price target.


8 December 2009 130

Figure 211: Porsche EV/EBITDA

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Adjusted EV/EBITDA

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Adjusted EV/EBITDA Source: Company data, Barclays Capital

Figure 212: Porsche key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E



Industrial EV/ EBITDA 5.3x 3.4x 10.8x 10.5x 3.8x 2.5x 1.8x

Industrial EV/ EBIT 5.9x 1.2x 2.0x (2.4) 3.7x 2.3x 1.5x

P/E 6.3x 2.6x 2.8x (6.6) (53.4) (84.2) 263.3x

FCF yield (%) 13.9 5.8 -24.1 -14.8 -0.3 28.1 4.6

Price/sales (%) 122 147 238 355 137 98 92


Dividend yield (%) 1.2 1.1 0.7 0.7 1.6 1.9 1.9


Industrial EV/sales (%) 152 252 192 -14 39 44 39

Industrial EV/ EBITDA 5.0x 3.6x 1.8x (0.7) 1.9x 2.1x 1.6x

Industrial EV/ EBIT 5.0x 2.1x (0.1) (0.7) 3.7x 4.1x 3.2x

P/E 5.9x 3.9x 1.9x 0.2x 3.6x 3.8x 2.5x

FCF yield (%) 8.7x 4.3x 1.7x (2.8) (52.9) (99.3) 310.6x

Price/sales (%) 10.1 3.5 -40.8 -34.2 -0.3 23.9 3.9

Price/book 169 246 141 154 136 115 108

Dividend yield (%) 2.2x 1.9x 0.6x 9.1x 7.9x 6.3x 4.6x



External risk – macroeconomic factors outside the control of the company, leading to a stronger demand and pricing environment than we currently assume.

Risks from financial transactions – Porsche plans to issue future equity and complete a merger of Porsche AG into VW AG. The pricing and terms for the equity issuance and future merger are not known at this point, and may be set in a way that prejudices owners of Porsche pref shares


8 December 2009 131

Figure 213: Porsche income statement

Year-end July (€mn) 2007/08 2008/09E 2009/10E 2010/11E 2011/12E 2012/13E 2013/14E 2014/5E

Porsche standalone

Units 98,652 75,238 89,000 107,000 114,420 118,216 122,587 127,161

Average selling price € 63,172 € 69,911 € 68,000 € 68,000 € 68,000 € 68,000 € 68,000 € 68,000

Vehicle revenues 6232 5260 6052 7276 7781 8039 8336 8647

Spare parts and accessories' revenue 516 400 412 424 437 450 464 478

Other revenue (from credit financing/leasing) 718 600 630 662 695 729 766 804

Revenue 7,466 6,260 7,094 8,362 8,912 9,218 9,565 9,929

Total operating performance 7,778 6,560 7,294 8,412 8,962 9,268 9,615 9,979

Other operating income 19,773 60,215 - - - - - -

Cost of materials -4,170 -3,318 -3,760 -4,432 -4,456 -4,609 -4,783 -4,964

Personnel expenses -1,358 -1,322 -1,470 -1,505 -1,586 -1,613 -1,674 -1,738

Depreciation and amortisation -569 -600 -704 -788 -790 -800 -838 -901

Other operating expenses -13,744 -60,558 -600 -710 -760 -790 -820 -850

EBIT 7,709 -4,897 760 977 1,370 1,456 1,500 1,526

EBIT margin 103.3% 4.0% 10.7% 11.7% 15.4% 15.8% 15.7% 15.4%

Adjusted/clean core EBIT 876 676 760 977 1,370 1,456 1,500 1,526

Adjusted/clean EBIT margin 11.3% 10.3% 10.7% 11.7% 15.4% 15.8% 15.7% 15.4%

Other financial income 859 497 -520 -500 -500 -500 -500 -500

PBT 8,569 -4,400 240 477 870 956 1,000 1,026

PBT margin 114.8% -70.3% 3.4% 5.7% 9.8% 10.4% 10.5% 10.3%

Income taxes -2,177 1,100 -82 -167 -304 -335 -350 -359

Tax rate (on pre-associate income) 28.8% 25.0% 34.0% 35.0% 35.0% 35.0% 35.0% 35.0%

Net income 6,392 -3,300 158 310 565 622 650 667

Adjustments/minority interests 101 100 350 417 544 572 587 595

Net profit Porsche AG 6,290 -3,400 -192 -107 21 49 64 72

VW contribution to Group

Units (000s) 5,000 4,700 4,800 5,000 5,400 5,600 5,800

Revenue 107,700 103,000 107,400 113,900 118,700 123,300 127,600

VW Other operating items -103,900 -100,800 -103,900 -109,000 -113,000 -116,800 -120,300

VW EBIT 3,800 2,200 3,500 4,900 5,700 6,500 7,300

VW financial result -300 -300 100 100 100 100 100

VW pre-tax 3,500 1,900 3,600 5,200 6,200 7,100 7,900

VW tax etc. -1,100 -700 -1,100 -1,100 -1,100 -1,100 -1,100

VW net income 2,400 1,200 2,500 3,500 4,200 4,900 5,300

VW minority at 62.6% (vs -1.50?) 1,501 751 1,564 2,190 2,628 3,066 3,316

Consolidated Porsche SE income statement (includes VW from 5 Jan 09)

Consolidated revenues 7,466 113,960 110,094 115,762 122,812 127,918 132,865 137,529

Consolidated EBIT 7,709 -1,097 2,960 4,477 6,270 7,156 8,000 8,826

Consolidated EBIT Margin 103.3% -1.0% 2.7% 3.9% 5.1% 5.6% 6.0% 6.4%

Consolidated adjusted EBIT 876 -1,097 2,960 4,477 6,270 7,156 8,000 8,826

Consolidated adjusted EBIT margin 11.7% -1.0% 2.7% 3.9% 5.1% 5.6% 6.0% 6.4%

Consolidated PBT 8,569 -900 2,140 4,077 6,070 7,156 8,100 8,926

Net income 6,290 -2,501 257 829 1,331 1,621 1,898 2,056

EPS ord shares 35.94 -14.29 1.47 4.73 7.60 9.26 10.84 11.74

EPS pref shares 35.95 -14.29 1.47 4.74 7.61 9.27 10.85 11.75

EPS core op'ns 30.19 -19.43 -1.10 -0.61 0.12 0.28 0.36 0.41



8 December 2009 132

RENAULT – POTENTIAL FOR GREATER COMMONALITY DRIVES 1-OVERWEIGHT RATING

We are initiating coverage of Renault (RNO) with a 1-Overweight rating and a €42 price target. Our 1-Overweight rating relies on the assumption that the ‘glass is half full’ in relation to future potential synergies from the Renault-Nissan BV (RNBV) alliance. Whilst we acknowledge that the company is currently in a far from secure position in balance sheet terms and is yet to show evidence of current profitability in its automotive business, we believe this leaves plenty of upside potential to the current share price.

Recent bull arguments for RNO have revolved around access to the early recovery in the US autos market, via the Nissan stake, and Nissan’s strong Chinese exposure. Whilst we agree that a strong position in the US market (as well as in those emerging markets which have remained resilient throughout the crisis) is likely to aid Nissan’s performance, we believe that this effect is already fully understood in relation to the RNO share, and would argue that investors can choose more direct US exposure via other names in the global sector.

We believe that additional value can be extracted from the RNO share via the potential for increased use of commonality on platforms shared with its Asian associate. The unlocking of such synergies has long caused heated debate among analysts (the alliance has now been up and running for 10 years and many would argue has yet to crystallise any significant synergies for RNO) and we believe that investors have tired, of late, of waiting for evidence of cost streamlining and thus place very little equity value in the RNBV alliance. But we also believe that RNO management are now whole-heartedly focused not only on cash management but also on turning their association with Nissan into something more immediately tangible. While we think that 2009E’s likely alliance cost savings will have been more a gut reaction to the crisis, we expect much longer-term actions to be in discussion and to start to bear fruit from 2010 onwards. We expect next March’s Geneva Motor Show to present a good opportunity for management to disclose a new alliance strategy and unlock the value of scale from the RNO share. Though we do not expect the full benefits of such a strategy to materialise until 2012E, we believe that increased focus on this longer-term potential will boost investor sentiment in the near term. We are also optimistic that 2010E will herald the beginning of an improved cash management strategy, which will include the sale of selected property assets and any non-strategic investments, such as the Volvo stake.

We are therefore initiating coverage of RNO with a 1-Overweight rating and a €42 price target, implying 18% potential upside from current levels.

Figure 214: RNO – headline data and valuation multiples (at current share price), 2008-2011E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 37,791 32,020 32,661 34,959 36,292

Clean EBIT 212 (863) 206 981 2,299

EBIT margin (%) 0.6 -2.7 0.6 2.8 6.3

BC EPS € 2.23 (10.30) 0.53 4.77 10.62

Consensus EPS € 2.23 (10.74) 0.37 4.27 7.46


Industrial EV/EBITDA 1.5 1.3 1.0 0.9 0.5

P/E 24.1 (3.1) 60.7 6.7 3.0


RENA.PA / RNO FP




Price (04-Dec-2009) €35.59



8 December 2009 133

Valuation: We base our €42 price target on a weighted average combination of a sum-of-the-parts valuation (to which we apply a 10% holding discount for the associate companies) and peer average EV/EBITDA multiples. For further detail please see valuation section.


Positives:

Greater potential for longer-term commonality/scale via Nissan alliance

Geographical breadth and access to fastest growing markets in 2010E via Nissan stake

Potential for debt reduction via exiting from non-strategic investments

Youthful model mix in recovering C segment

Risks to our 1-Overweight view:

Under-delivery on expected alliance benefits

Current high gearing levels add risk to share, especially if further cash injection is required for Avtovaz (though we view this as unlikely)

With more than 60% of earnings generated by Nissan (>70% by total associate contribution) any significant downturn in either Nissan’s or Volvo’s earnings stream would have a major knock-on affect on Renault’s own bottom line.

Further alliance savings possible through greater commonality and modularity

One of the common strategies that OEMs have been emphasising in recent months is the ability to leverage global scale and parts commonality. The most widespread argument at present relates to the necessity of reaching 1mn units per platform. From our analysis of current platform capabilities by manufacturer, it would at first appear that the RNO-Nissan alliance is ideally suited to win in this area. In the B & C segments, as a combined group, the two companies stand just ahead of Toyota, and 2% pts behind VW, in the scale stakes, with 14% share of total available capacity. On a segment by segment basis, the RNO-Nissan group is set to achieve well above the requisite 1mn units/platform in the B & C segments by 2011E and approaching the 1mn level on its D platform (Figure 216).

Figure 215: Although RNO-Nissan far exceed PSA, there is still scope for additional commonality on B, C & D platforms

1,132

994

745

233

2,103

Renault-Nissan B(Clio)

Renault-Nissan C(Megane)

RNO-Nissan D(Laguna)

PSA PF1 (207) PSA PF2 (308) PSA PF3 (408)


1372 1,132

994

745

233

2,103

Renault-Nissan B(Clio)

Renault-Nissan C(Megane)

RNO-Nissan D(Laguna)

PSA PF1 (207) PSA PF2 (308) PSA PF3 (408)


1372



8 December 2009 134

Achievement of scale but yet to realise commonality potential As we argued in the front section of this report, to gain a competitive edge manufacturers need to not just produce 1mn units per key volume platforms, but also to exploit that scale through common engineering and parts specifications. Whilst the RNO-Nissan alliance may have already extracted significant economies of scale based on joint purchasing volumes (with common suppliers used for >40% of total group purchasing and RNPO now responsible for 100% of group purchasing – see discussion below), a closer analysis of the actual commonality between models on its so called shared platforms shows that there is still a long way to go before a true modular strategy is achieved. In other words, we believe that RNO-Nissan have achieved 80% of phase 1 (purchasing/scale) of the modular process, around 30% of phase 2 (commonality) but are only just beginning to experiment with phase 3 (full modularity).

Figure 216: Further savings potential from greater commonality and modularity

Phase 1:Purchasing/

Scale

Phase 2:Commonality

Phase 3: Modularity

Phase 1:Purchasing/

Scale

Phase 2:Commonality

Phase 3: Modularity


Background to the alliance

Renault and Nissan signed a partnership agreement 27 March 1999 in order to develop potential synergies from combining the strength of the two companies, whilst at the same time protecting each company’s autonomy and separate brand identity. A further step was taken 28 March 2002 when Renault-Nissan b.v. (RNBV), a joint company incorporated under Dutch law and equally owned by Renault SA and Nissan Motor Co. Ltd, was formed. RNBV is responsible for the strategic management of the alliance.

Figure 217: RNO-Nissan alliance structure

Dacia 99.43%

Renault Samsung Motors 80.1%

AB Volvo 20.74%

AvtoVAZ 25%

RENAULT NISSAN

44.3%

15%(1)

Note: (1) No voting rights

RENAULT-NISSAN b.v. Dedicated Alliance team

Joint companies RNPO (Renault-Nissan Purchasing Organization)

RNIS (Renault-Nissan Information Services)

50% 50%

100%


RNBV has currently achieved 80% of joint purchasing

potential, 30% of commonality and only a minimal proportion of

potential modular savings


8 December 2009 135

Why has it taken so long? Despite the promise of significant synergies since the inception of the alliance 10 years ago, investors believe it has taken too long for management to generate discernable benefits from RNBV. Cultural differences between the two companies, we believe, have slowed the process, but also lack of driving force from management while auto markets were supportive. However, the harsh realities of a global recession, we believe, have finally forced management to act. On 29 May 2009 the group presented a detailed strategy for potential alliance synergies in 2009, targeting €1.5bn of combined savings, €678m for RNO. The strategy focuses on eight key areas for development, including purchasing, powertrain & vehicle engineering and manufacturing.

Why we believe significant savings will be achieved in 2009 and beyond We believe that the alliance has now become one of the key areas of focus for Renault (along with cash generation) and that they are no longer talking about theoretical savings but are now taking definitive action to generate those savings.

There is now an alliance team specifically in place to oversee the performance of the alliance, with 12 people dedicated to the generation of future synergies and divided between nine key areas: purchasing (RNPO); zero-emission business; global logistics; IT; powertrain; common platform & parts; support functions; research and advance technologies and global sourcing. Management of the separate functions within Nissan and RNO will now have to report into this “alliance committee” who we believe are currently in the process of setting future alliance targets. We expect to hear more definitive targets for 2010 and beyond in 1H10E.

Figure 218: €1.5bn of RNO-Nissan synergies targeted for FY09

Figure 219: RNO Group targets €678m of these synergies

Manf'g and logistics

363

Research & engineering

115

Sales & Marketing

147

Purchasing157

Vehicle engineering

279

IT & Support, 48

LCV, 102

Powertrains289

Powertrains134

LCV 41

IT & Support

12

Vehicle engineering

74

Purchasing105

Sales & Marketing

63

Research & engineering

70

Manf'g and logistics

179

Source: Company data Source: Company data

12-strong alliance committee reinforces group’s dedication to

realizing full potential of alliance - more focus on phases 2 & 3 of

the modular process (commonality and modularity)


8 December 2009 136

Figure 220: Barclays Capital estimated Industrial EBIT walkdown showing expected alliance savings FY09E (€mn)

60

-288

140

13070

100

-80 180 -100

-1,475 -1,263

Indu

stria

l EBI

T20

08E

Purc

hasi

ng

Com

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1. Common purchasing well utilised by alliance but still further savings to realise

Common purchasing has been an area targeted by RNBV since its inception. However, the original scope of the Renault-Nissan Purchasing Organisation (RNPO) back in 2002 was only for 30% joint purchasing. The ease with which additional economies of scale could be achieved by increasing the group’s purchasing commonality was further realised in 2008 when RNPO expanded its scope to cover 90% of alliance purchasing turnover. In 2009 this increased yet further such that by year end RNPO will cover 100% of purchasing. We expect scale economies from this area to provide €100m of savings for RNO in 2009 but since we believe that this is an area where 80% of synergy savings have been achieved already, we expect savings to reduce to just €50mn per annum going forward.

2. Savings from manufacturing & logistics to accelerate

Like management, we expect to see the greatest achievement in the field of manufacturing and logistics as the company begins to further realise its potential for sharing facilities (or phase 2 of the alliance process). By the end of 2009 the alliance will cross-manufacture a total of 13 vehicles, including four new vehicles in 2009. For instance, Renault plants currently produce Nissan vehicles in Korea (Almera) and Brazil (Livina), whereas Nissan assembles Renault vehicles in South Africa (Sandero), Mexico (Clio) and Spain (Trafic).

On a gross level, we expect the company to fully achieve its €179m target in this area in FY09 but that these savings will be entirely matched by additional costs of production shutdowns in the year. However, we expect these savings to accelerate in the mid-term as new models come online and provide further opportunities for cross-manufacturing. By 2012E we forecast €150mn of annual savings from this source.

3. Greater scope for commonality of models

Currently common platforms account for 70% of the alliance’s production volume but the percentage of shared components across models on a shared platform is still very low. For instance, the B platform – the group’s largest comprising models such as the Renault Clio, Modus; Nissan Versa, Micra; and Dacia Logan and making up 34% of the total group global production – was the first where management saw the opportunity for commonality. At Renault’s investor day back in September 2004 management presented the benefits for the

100% shared purchasing via RNPO in 2H09 provides €100m

of likely savings

Production shutdown costs in 2009 fully compensated by alliance manufacturing and

logistic savings of €179m in 2009

Only 70% of alliance production is on common platforms and

currently only 35% commonality of components even on a

common platform


8 December 2009 137

new Modus model of sharing components with both the Micra and Clio. Total commonality at that point was 50% across the Clio/Modus range and 30% across the Micra/Modus. However, five years on, we believe commonality is still only around 35% in total across all models on the B platform.

Figure 221: Commonality only c35% across all models on RNO-Nissan’s biggest platform

RNO-Nissan B platform As reported by RNO Sep 04 FY09E Barclays estimates

Commonality (%) Clio/Modus Micra/Modus Across all B platform models*

Upperbody parts 25% 5% 10%

Platform parts 80% 60% 50%

Powertrain 100% 100% (diesel)/

0% (petrol) 70%

Total 50% 30% 35%

Source: Company data and Barclays Capital

On the C platform - Mégane/Scénic/Qashquai/Sentra etc - (38% of total group production in Europe but only 22% globally) we believe there is even less commonality at present, thus greater scope for future savings. Even more urgently, the D segment where RNO currently makes a double-digit operating loss, following the lack of payback from significant Laguna investments, remains a key area where further synergies must be achieved, as we believe there is currently very little commonality across vehicles in this segment. The new SM5 in Korea in 2010E should help provide shared capacity on this underutilised platform.

In the field of shared engineering of models across platforms, we expect the new Mégane and Scénic models to have improved the commonality ratios on the C platform and that RNO will thus benefit from €70mn of savings in FY09E. However, there is still a long way to go before full modularity can be achieved across all RNO-Nissan platforms. Although we believe this to be an area with the largest potential for long-term improvement, we also think that it will be the area in which savings will take the longest to achieve as the company must wait for the renewal of its full model portfolio before full modularity can be realised. We see scope for much greater platform commonality in 2010 and beyond, with new model launches in the D and LCV segments providing opportunity for further platform-sharing (see discussion on model cadence below) but it will not be until 2012 (with new generation Clio) that these savings will really start to accelerate with the potential, we believe, for €400mn of YoY cost improvement.

4. Ongoing improvement on commonality of powertrains

Co-operation on powertrain development and manufacture has been exploited by the alliance for some years now – for instance back in 2002 the Nissan Almera was fitted with Renault’s 1.5l diesel engine in Europe. Currently 50% of powertrain components are shared and with increased emphasis on CO2 saving technologies, further sharing of development costs and manufacturing across the partnership should be a significant benefit. We believe this area can contribute €200mn per annum in savings for RNO, though again these will be back-end loaded (for further detail see Figure 222).


8 December 2009 138

5. Many other areas for savings have been identified – notably research into new technologies

Finally, we expect savings in R&D (particularly in the area of headcount in 2009) and SG&A, to accelerate in future years. With an increased emphasis on electric vehicles, the ability to share battery technology with Nissan (and its partner SAIC) should generate significant savings for the group, as will the streamlining of the two companies’ separate R&D departments into one division

Figure 222: We expect synergy cost savings to be mainly back-end loaded with the full modular potential not realised until 2012E

RNO EBIT walkdown (€mn) 2H09E 2009E 2010E 2011E 2012E

Prior year automotive clean EBIT (€mn) (884) (288) (1,263) (203) 582

Volume (variable costs) (122) (1,100) 300 290 230

Raw materials 176 0 (300) 0 0

Price/mix 35 (350) 450 (300) 0

Currency (120) (275) (70) (30) 0

Warranty 140 250 50 0 0

Renault standalone tailwind/(headwind) 110 (1,475) 430 40 230

RNBV alliance savings:

Purchasing 100 50 50 30

Commonality of powertrains 130 100 225 250

Commonality of product 70 80 100 150

Aid to suppliers (80)

Total purchasing/commonality savings 130 220 230 375 430

Gross manufacturing & logistics 180 200 250 400

Production stoppage costs (100)

Manufacturing & logistics 96 80 200 250 400

R&D, SG&A 140 100 100 120

Other alliance savings 60 100 100 130

Total other alliance savings 144 200 200 200 250

Total gross alliance savings* 370 680 630 825 1,080

YoY change in automotive EBIT 489 (975) 1,060 785 1,310

Current year automotive clean EBIT (€mn) (395) (1,263) (203) 582 1,892

Industrial EBIT margin (%) -2.6 -4.2% -0.7% 1.8% 5.5%

Source: Company data, Barclays Capital * ex-aid to suppliers and costs of production stoppage

Whilst the €680mn of savings we forecast for 2009E we expect to have been the ‘easy’ savings or more short-term cost cutting associated with a crisis year. We therefore expect a slight slowdown in savings in 2010E as we are looking for more considered, longer-term alliance benefits to start to materialize but really expect these to be much more back-end loaded and to fully ramp up from 2012E onwards.

In 2010E we therefore forecast a further €630mn of alliance savings at Renault as per the breakdown provided above. We believe company management will provide the investment community with a schedule of its own targets in early 2010 along similar lines to those estimated above and showing that savings will accelerate gradually until 2012E when the full modular potential can truly begin to be realised.

In total we credit RNO with the full €680m of targeted alliance

synergies in FY09, although on a net level many of these will be negated by company specific

headwinds, such as volume, FX and price/mix.


8 December 2009 139

RNO Automotive to remain loss-making in 2010E but consensus too pessimistic

Our argument for buying into the RNO share lies not, therefore, in where we see the company’s results in FY09E or even in 2010E (we forecast a -€203mn Automotive clean EBIT loss in 2010E, €206mn positive EBIT at the group level), but the potential that we see the company unlocking in the longer term. We believe that the market is underestimating the potential of these savings because it has been disappointed in the past by failure to produce synergies. However, we believe that commonality is finally a theme high on the agenda for all management meetings and that investors will start to hear more in coming months about the tangible benefits, and how exactly the group plans to realise those benefits. Indeed, we expect the Geneva Motor show to be a good forum for presenting a new alliance strategy (along similar lines to Fiat’s 4 November Chrysler synergy presentation), which is likely to focus on both improved commonality of platform production across all models but also potential R&D savings from greater pooling of resources. With firm targets and step-by-step detail on achievability of those targets, we expect the market to gradually give the company more credit for these savings thus providing momentum to the share.

For 2010E we expect alliance savings to combine with a ramp up in manufacturing savings, as production recovers on the back of RNO’s strong model mix (with the youthful Mégane likely to capitalise on our theory that the C segment will be the fastest growing segment in Europe in 2010E). The Mégane should also herald the beginning of the modular approach which will eventually be rolled out on all future models.

Figure 223: Despite caution on top line, our EPS estimates remain above consensus

RNO Group 2010E Barclays Consensus Variance (%)

Revenue (€mn) 32,661 33,152 -1.5

EBIT (€mn) 206 183 12.6

EPS (€) 0.53 0.51 3.9


Despite remaining below consensus on the overall demand equation in 2010E and also factoring in expected raw material increases of €150/vehicle, further FX headwinds and weaker overall pricing, our projected gross cost savings and the impact of an improving C segment mix, take us to an above consensus EBIT and EPS forecast for 2010E. We use consensus estimates for Nissan and Volvo associate contribution since both companies are currently non-rated.

Although there have been recent minor upgrades to market assumptions for RNO’s earnings and to analyst recommendations, we still believe the market is drastically underestimating the company’s longer-term earnings potential based on the new concerted effort to achieve full alliance synergies.


8 December 2009 140

Geographical scope to enable further earnings expansion We prefer to highlight RNO’s alliance synergy potential rather than the more popular bull argument for buying into RNO’s superior geographical reach, via its association with Nissan, which we believe is well understood and already priced into the share. With Nissan historically contributing >60% of Renault group EPS, of course Nissan earnings growth will drop down to the RNO bottom line. We therefore agree that Nissan’s 7% US market share, such that every 1m addition to the US SAAR would bring €1.83 to RNO EPS, helps our bull case, especially since we are forecasting a recovery of 1.6m units in the US market in 2010E to reach a 12m SAAR. Since we use consensus earnings numbers for Nissan to calculate the associate income contribution from the Asian OEM and believe that consensus is currently 0.5-1mn units behind our own US SAAR assumption, this could therefore provide some further upside potential for RNO. However, we prefer not to base our bull case purely on this well-discussed theme, especially since the Nissan share is publicly traded and can therefore be invested in directly.

Figure 224: Every additional 1m units in US market, would boost RNO EPS by almost €2

Renault sensitivity to US

US SAAR change (m) 1.0

Nissan market share in US 7.0%

Nissan incremental units sold (units) 70,000

Average price per Nissan unit (EUR) 13,400

Est. incremental contribution per unit (EUR) 5,000

Tax rate 35%

Multiple to incremental earnings 5.0

Renault ownership in Nissan 44%

Value to Renault (€mn) 504

Value per Renault share (€) 1.83

Extra value as % of Renault current price 5.4%


Likewise, although we agree the attraction of Nissan’s exposure to the Chinese market (20% of global Nissan sales) and the combined RNO-Nissan group’s geographical breadth (though E European and Russian markets have yet to show signs of recovering into 2010E), we again believe that this theme is already well understood by the market.

Figure 225: Analyst earnings assumptions overly cautious

Figure 226: Market ratings too cautious for RNO

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8 December 2009 141

Youthful product cadence to boost 2010E mix With the benefit of alliance scale, the combined RNO-Nissan global market share stands at 9%, making the partnership the third-largest group in the world in terms of sales. Although 2009 was a peak year for RNO’s model cadence, scrappage benefits boosted A&B share at the detriment of the C segment and so the benefits of improved mix from the full Mégane roll out were not felt as strongly as in a more ‘normal’ year. Although 2010E will be a tough market for small-car market skewed manufacturers as the overhang from scrappage phase out will take its toll on the European market (we forecast A&B segments combined market share to fall 400bp in 2010) , RNO’s strong presence in a segment C set to grow, we believe, 200bp YoY should help boost mix.

Figure 227: RNO’s Mégane to provide mix boost from C-segment growth in 2010E

Market Share (%) 2008 2009 2010 2011 2012

A – Basic 10.5 13.7 11.4 11.5 12.0

B – Small 29.5 33.1 31.4 32.8 32.8

Memo: A + B 40.0 46.8 42.8 44.3 44.8

C - Lower Medium 31.4 29.6 32.6 31.8 31.0

D - Upper Medium 8.0 7.0 6.7 6.2 6.1

Memo: C + D 39.5 36.6 39.3 38.1 37.1

Memo: A - D 79.4 83.4 82.1 82.4 81.9


Dacia’s Logan range has been an unmitigated success for the company. The new Logan SUV is due to be launched in 2Q10E and should further bulk out the mix of this profitable brand. Likewise, new LCV products (Master in 10E, followed by Trafic in 2011E), which traditionally make mid-single digit margins for the group, should also aid core profitability.

Figure 228: RNO forecast new model introduction schedule, 2009-2012E

2009E 2010E 2011E 2012E

Renault Scénic, Fluence

Alpine, Mégane CC, Master, Safrane,

Laguna (f/l)

Mégane SUV, Trafic (ng)

Clio (ng), Electric City Car, Espace

Dacia Logan SUV Logan (ng)

Samsung (RSM) SM3 SM5 SM7

Source: JD Power, trade press, company data and BC estimates; f/l – facelift; ng – new generation

Figure 229: RNO-Nissan group have the best emerging-market after VW

Market Share Rank


Porsche-VW Group 20.6% 11.0% 1.4% 4.5% 10.6% 2 1 9 7


Fiat Group 24.9% 0.5% 0.4% 2.6% 5.1% 1 24 11 11

PSA Group 6.1% 2.3% 0.0% 2.8% 2.8% 5 15 10

BMW Group 0.1% 0.6% 0.1% 0.7% 0.5% 15 23 15 17

Daimler Group 0.4% 0.4% 0.2% 0.6% 0.4% 12 25 14 22



8 December 2009 142

Below average capacity utilisation leaves significant scope for upside

Our analysis of capacity utilisation in the volume sector shows that RNO has one of the lowest levels in the market – leaving significant room for improvement. Government involvement in the French auto industry has tied RNO’s hands to some degree when it comes to improving its utilisation ratios, although the company appears to have found ways to gradually phase out full assembly roles at Sandouville, Flins and Valladolid, which we expect to ease the cost structure. Also, importantly, we see significant potential for streamlining of products across brands – for instance the SM5 in Korea should hopefully ease the burden on the D platform and Nissan/RNO production in Togliatti, Russia should help Avtovaz achieve a lower breakeven point. Yet more potential benefits to reap from the conglomerate structure.

Figure 230: RNO production & cap utilisation vs average for volume market, 2008A-15E

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Focus on electric

Many investors worry that Renault’s focus on electric vehicle development is a risk to the share given the significant financial outlay necessary. However, whilst we do not necessarily credit RNO’s target of 10% market share for electric vehicles by 2020, we agree with the company’s premise that the only way to make electric vehicles cost efficient is to roll them out en masse (a similar strategy to BMW’s use of ‘Efficient Dynamics’ across all models). We also believe that the US$6bn (€4bn) that the group has announced it will need to spend in the field of EVs will be spread thinly over a long timeframe. In fact the company still targets -20% cut to cash R&D spend in 2009E, despite its emphasis on EV development, and does not merely see this cut as a gut reaction to the current crisis but believes that spending can be maintained at this low level (mainly as a result of sharing resources across the entire alliance, rather than depending on separate R&D functions at RNO and Nissan). RNBV is well placed to capitalise on its scale and its in-house battery development with NEC in order to share the costs of its EV investment. Indeed, we believe that the €4bn to be spent on EV development will be spread over 10 years and shared between both companies, such that RNO’s annual R&D spend will only increase by €150mn per annum (8% of current R&D costs).

Moreover, the €4bn is likely a gross expenditure; net expenditure is likely to be lower as government incentives (or low cost financing) will to aid the burden of developing electric vehicles. For example, Nissan will receive a US$1.6bn loan from the US Department of Energy to add flexibility to its Smyrna, Tennessee, manufacturing plant to produce zero-


8 December 2009 143

emissions vehicles and lithium-ion battery packs. The loan will help finance retooling the 26-year-old plant and build a new facility to manufacture batteries. When fully operational, the vehicle assembly plant will have the capacity to build 150,000 EVs a year and have an annual capacity of 200,000 batteries. The plant currently has a capacity of 550,000 vehicles but even before the downturn was only working at 73% capacity utilisation. The expansion into electric vehicles will likely boost utilisation rates for existing (non-electric) models at the plant - 2 cars and 3 trucks – thus in reality using the government money to aid core operations as well as new technology investments.

Cost savings and disposals should aid longer-term debt reduction High debt levels and lack of significant cash generation have weighed on the RNO share in recent years. We agree that this is not a share for leverage-averse investors in the short term but we believe that the market is underestimating the company’s potential to materially improve its cash position. Company meetings and recent results presentations reinforce the notion that management are now firmly focused on the need for positive cash generation, with positive FCF in 2009E being a firm target. Of course, there will be a major ramp up in production levels in Q409E which will aid that goal but we think continued tight inventory management will also enable further cash benefits in 2010E. However, with Industrial net debt levels currently at €7.2bn (€8.3bn after pension) leaving gearing at 51%, RNO will struggle to strengthen its balance sheet and return to investment grade debt ratings via operational cash flow alone.

Figure 231: RNO debt levels peaked in 2008 – reduction of debt remains key focus of mgt

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The company has lined up €700-1bn of assets which it aims to sell in 2010E. The positive FCF target for 2009E was initially set presuming €300-500m of these asset liquidations would occur in FY09, or in other words presuming that the operational cash flow of the business would be a negative €500mn. The fact that the company can still target positive FCF even without the aid of these sales, has been helped by scrappage-induced sales and also the company’s strong order book going into Q409. However, we feel that the market is not giving enough credit to RNO for its ability to generate strong working capital inflows as production increases. Despite a change in payable terms in FY09, RNO is likely to generate €2.3bn of inflows from WC in 2009E, after €1bn cut to inventory. The company argues that this new lower inventory level (c150,000 units at dealers and 160,000-170,000 on the group balance sheet) can be maintained going forward, helping to generate, we believe, positive Industrial FCF in 2010E also.


8 December 2009 144

Dividend income no longer provides FCF boost

Dividends from associates have traditionally brought in c€600m per annum to RNO’s cash flow but have become a much smaller income stream in 2009 and are likely to disappear entirely from 2010E cash flow (although leaving room for further upside surprises if Nissan were to declare a dividend in 2009). Whilst we expect the Nissan dividend to return in 2011 we do not see dividend income returning to pre-crisis levels in the mid-term.

Volvo disposal likely in short term

RNO is the largest shareholder in Volvo with a 21.8% stake. Though management will not confirm the possibility, many press articles have highlighted the likelihood of Renault considering the dispose of this non-strategic stake. Management have repeatedly emphasised the need to significantly reduce the company’s current debt burden, and so we believe that a disposal within the next 12 months would be a preferred option, were a buyer to be found. We estimate that a potential disposal could generate €3bn of cash at current market levels. Of course RNO would look to maximise the return on its Volvo investment, therefore we expect that it will bide its time for a good exit window. Unsurprisingly there has already been considerable speculation in the press and investment community surrounding this non-core, liquid asset, but as we have seen in the past with M&A activity of this scale, no matter how well anticipated, when the action happens, the market can still react positively. If RNO were to dispose of its Volvo stake next year, we anticipate that it would provide a positive catalyst for the RNO stock and aid the group’s longer-term debt reduction.

Avtovaz a short-term drag but long-term opportunity

We expect negative headlines relating to Renault’s investment in Avtovaz to continue for the next few months. However, we do not view it as likely that Renault will input any more cash into the Russian manufacturer. Rather we expect RNO to provide expertise and scale, so that when the Russian market finally starts to recover, the company will be well positioned to capitalise on the recovery. With 25% market share in the Russian market, Avtovaz has been hard hit as the market crashed down from close to 3m vehicles in 2008 to <1.5mn in 2009E and was not prepared for the necessary cuts to production caused by a 400,000 drop in unit sales. However, with new management in place and a plan to reduce the breakeven point to 400,000 vehicles, as well as the ability for Renault and Nissan to leverage off Avtovaz’s existing platform, we see huge potential for upside from this stake. In the very near term we advise buying into any dips in the Renault share on the back of negative news flow, as political pressure may try to force RNO to inject further funds to the manufacturer. We think RNO will stand firm and provide strategic and operational expertise but no further cash outlay.

Rating We are initiating coverage of RNO with a 1-Overweight rating, believing that the market is not currently crediting the share with sufficient potential for significant Alliance synergies in 2010E and beyond. Whilst we believe that the company’s exposure to high growth markets in 2010E via its Nissan stake is a well understood theme, and we also remain cautious on the company’s current debt structure, we believe that once the company properly discloses its new Alliance targets to the market, the resultant broker upgrades will provide 18% upside to the current share price.

Valuation Methodology We value the RNO share using a SotP methodology which we confirm against historical and peer average EV/EBITDA multiples to reach our €42 price target:

We believe a disposal of part or all of Renault’s 21.8% stake in

Volvo will be the preferred option within the next 12 months

We do not view it as likely that Renault will input any further

cash into Avtovaz


8 December 2009 145

SotP

Using a sum-of-the-parts valuation we arrive at a €42 price target for Renault, or 18% upside potential to its current market price. We base our calculation on a blended average of peer Industrial EV/sales and Industrial EV/EBITDA multiples for the core Autos business and bring in associates at market value. However, we also apply a 10% discount to the NAV in line with the average discount that the market has historically applied.

Figure 232: Renault is currently trading at a 20% discount to its SotP, versus a historical average of 10%

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8 December 2009 146

Figure 233: RNO – Our SotP assumption leads us to a 1-Overweight rating and €42 price target

NAV, RNO €mn € per share Remarks

Renault Auto @ PSA multiple 4,963 18 15% 2011E EV/sales (in line with Peugeot)

Renault Auto @ PSA multiple 7,782 28 2x 2011E EV/EBITDA (in line with Peugeot)

Renault Auto Average 6,373 23

Renault FS (0.8x equity) 1,528 6 0.8x book value

Renault Core 7,901 29

Nissan stake at Market 10,635 39 44.3% of Nissan share price of JPY605; EUR-JPY of 130

Volvo stake at market 2,861 10 20.9% of Volvo share price of B: SKr66.6; SKr 65.5 A shares, EUR-SEK at 10.5

Avtovaz stake at market 23 0.1 25% stake at market value

Group EV 21,420 78

Net debt (7,293) -26 FY10E BS date

Pension Underfunding (1,046) -4 FY10E BS date

Minorities (517) -2 FY10E BS date

Options exercise (Treas. Sh.s) 234 1 FY10E BS date

SOTP (base assumption) 12,798 46

TP applying Holding discount 11,518 42 10% discount

Current share price 35.59


EV/EBITDA

We also cross-check our SotP calculation against peer and historical average multiples. Historically RNO has traded at an 8-year average of 6x unadjusted (ie, pre-associate stake) EV/EBITDA (vs 2.4x at PSA and 3.4x for the sector as a whole). Looking out to 2011E, when we expect autos markets to have normalised to a greater degree, our above consensus EBITDA estimates put RNO at only 4.5x at current share price. We believe that the company should trade closer to its historical level of 6x, which would imply a value of €43/share.

Figure 234: Renault Group historical EV/EBITDA implies the share is currently undervalued

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2000 2002 2004 2006 2008 2010E 2012E 2014E

Historical average UNADJUSTED EV/EBITDA Source: Company Data and Barclays Capital

We give a greater weight to our SotP valuation, thus on a weighted average combination of both these valuation metrics we derive a €42 price target for the share.


8 December 2009 147

Figure 235: RNO key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E

Valuation Multiples at Current Price

EV/sales 10% 13% 11% 11% 11% 13% 10%

EV/Clean EBITDA 1.2x 1.3x 1.5x 1.7x 1.2x 1.1x 0.6x

Unadjusted EV/EBITDA (pre-Associates) 8.7x 8.6x 10.2x 11.5x 6.7x 5.0x 3.4x

EV/Clean EBIT 8.2x 5.6x (13.5) (2.7x) (17.4x) 7.3x 1.8x

P/E 7.7x 9.7x 24.1x (3.4x) 65.3x 7.3x 3.3x

FCF Yield -0.1% 3.9% -21.7% 7.9% -1.1% -6.2% 13.1%

Price/Sales 62% 72% 42% 32% 31% 29% 28%


Dividend yield 3.6% 3.8% 0.0% 0.0% 0.0% 1.4% 4.6%

Valuation Multiples at €42 Price target

EV/sales 10% 13% 11% 19% 19% 20% 16%

EV/Clean EBITDA 1.2x 1.3x 1.5x 2.8x 2.0x 1.7x 1.1x

EV/Reported EBITDA 8.7x 8.6x 10.2x 12.9x 7.6x 5.6x 3.8x

EV/Clean EBIT 8.2x 5.6x (13.5) (4.6x) (28.7x) 11.2x 3.0x

P/E 7.7x 9.7x 24.1x (4.2x) 81.0x 9.0x 4.0x

FCF Yield -0.1% 3.9% -21.7% 1750.0% NA NA NA

Price/Sales 62% 72% 42% 39% 39% 36% 35%


Dividend yield 3.6% 3.8% 0.0% 0.0% 0.0% 1.2% 3.7%


Risks to price target Downside risks to our price target are as follows:

Risks to our cost commonality assumptions, ie, under-delivery on expected alliance savings

Current high gearing levels add risk to share

With more than 60% of earnings generated by Nissan (>70% by total associate contribution) any significant downturn in either Nissan or Volvo’s earnings stream would have a major knock-on affect on Renault’s own bottom line.

Credit perspective Barclays Capital credit analysts, Rob Perry and Darren Hook, rate Renault Market Weight. They believe that Renault's credit metrics will materially improve in 2010 and it can avoid significant cash burn through next year, despite the planned phasing out of European incentives. They subsequently believe that Renault should be able to justify the ratings agencies' stable outlook.


8 December 2009 148

Figure 236: RNO Group income statement, 2006A-2012E


Revenues 40,332 40,682 37,791 32,020 32,661 34,959 36,292

Cost of sales (31,343) (31,408) (29,659) (25,776) (25,476) (26,918) (27,582)

Gross profit 8,989 9,274 8,132 6,244 7,185 8,041 8,710

Memo: Gross Margin (% of sales) 22.3% 22.8% 21.5% 19.5% 22.0% 23.0% 24.0%

Cost of sales financing (985) (1,121) (1,292) (1,057) (1,045) (1,119) (1,161)

Research and development (1,963) (1,850) (1,858) (1,814) (1,850) (1,985) (2,063)

Selling, general and administrative expenses (4,978) (4,949) (4,770) (4,236) (4,084) (3,956) (3,186)

Clean EBIT (Operating margin) 1,063 1,354 212 (863) 206 981 2,299

Memo: Operating margin, % 2.6% 3.3% 0.6% -2.7% 0.6% 2.8% 6.3%

Memo: Clean EBITDA 3,898 4,219 3,155 2,463 3,289 4,290 5,738

Other operating income and (expenses) (186) (116) (329) (400) (150) (150) 0

Reported Operating income 877 1,238 (117) (1,263) 56 831 2,299

Memo: Operating income, % 2.2% 3.0% -0.3% -3.9% 0.2% 2.4% 6.3%

Financial income/(expense) 61 76 441 (300) (200) (200) 0

Share in associate net income 2,277 1,675 437 (1,050) 310 800 1,100

...Share in NI (loss) of Nissan Motor 1,888 1,288 345 (400) 400 600 800

...Share in NI (loss) of AB Volvo 384 352 226 (300) 60 200 300

...Share in NI (loss) of Avtovaz & other assocs 5 35 (134) (350) (150) 0 0

Pre-tax income 3,215 2,989 761 (2,613) 166 1,431 3,399

Current and deferred taxes (255) (255) (162) 0 0 (177) (644)

Memo: Tax rate 27% 19% 50% 0% 0% 28% 28%

Group Net Income 2,960 2,734 599 (2,613) 166 1,254 2,756

Minority interest share of NI 74 65 28 30 30 30 30

Net income, Renault share 2,886 2,669 571 (2,643) 136 1,224 2,726

NoShares (average) 256,994 258,621 256,552 256,628 256,628 256,628 256,628

Reported EPS (average shares, pre dilution) 11.23 10.32 2.23 (10.30) 0.53 4.77 10.62

DPS (Euros) 3.10 3.80 0.00 0.00 0.00 0.50 1.60

Segmental Revenue:

Automotive 38,409 38,679 35,757 30,230 30,831 33,089 34,382

Financial Services 1,923 2,003 2,034 1,790 1,830 1,870 1,910

Group Revenues 40,332 40,682 37,791 32,020 32,661 34,959 36,292

Automotive revenue growth -2.7% 0.7% -7.6% -15.5% 2.0% 7.3% 3.9%

FS revenue growth 2.3% 4.2% 1.5% -12.0% 2.2% 2.2% 2.1%

Group revenue growth -2.4% 0.9% -7.1% -15.3% 2.0% 7.0% 3.8%

Segmental EBIT:

Automotive EBIT 486 858 (288) (1,263) (203) 582 1,892

Financial Services EBIT 492 472 487 400 409 399 407

Group EBIT 1,063 1,354 212 (863) 206 981 2,299

Segmental EBIT Margin %:

Automotive EBIT % 1.3% 2.2% -0.8% -4.2% -0.7% 1.8% 5.5%

Financial Services EBIT % 25.6% 23.6% 23.9% 22.4% 22.4% 21.3% 21.3%

Group EBIT % 2.6% 3.3% 0.6% -2.7% 0.6% 2.8% 6.3%



8 December 2009 149

Figure 237: Renault Industrial and group balance sheet, 2006A-2012E


Property, plant and equipment & intangibles 16,263 16,788 16,862 16,326 15,621 15,803 15,918

Investments in associates 12,943 12,956 13,745 13,745 14,045 14,345 14,645

Investments in non-consolidated Co's 2,401 2,423 2,186 2,186 2,186 2,186 2,186

Other non-current financial assets 527 585 964 964 964 964 964

Deferred tax assets 588 603 523 523 523 523 523

Total Industrial non-current assets 32,722 33,355 34,280 33,744 33,339 33,821 34,236

Inventories 5,301 5,927 5,261 4,307 4,392 4,623 4,804

Automobile receivables 2,210 2,177 1,846 1,574 1,605 1,632 1,696

Other current financial assets 1,678 1,184 1,167 1,167 1,167 1,167 1,167

Other current assets 1,633 1,839 2,106 2,106 2,106 2,106 2,106

Cash and cash equivalent 4,963 3,697 1,141 4,189 4,087 3,369 4,212

Total Industrial current assets 15,785 14,824 11,521 13,342 13,357 12,897 13,985

Total Industrial assets 48,507 48,179 45,801 47,086 46,696 46,718 48,221

Total Finance Co Assets 25,573 25,645 23,053 20,305 20,751 21,198 21,644


Total Industrial non-current liabilities 7,306 7,182 7,338 10,338 10,338 10,338 10,338

Total Industrial current liabilities 20,201 19,010 19,147 19,330 19,605 19,611 19,775

Total Industrial liabilities 27,507 26,192 26,485 29,668 29,943 29,949 30,113

Total Finance Co Liabilities 23,207 23,260 20,895 18,445 20,751 21,198 21,644

Group Shareholder's equity 20,588 21,577 18,959 15,846 15,813 16,739 19,084

Minority Interests 483 492 457 487 517 547 577

Group Shareholders' Funds 23,366 24,372 21,474 16,333 16,330 17,286 19,661

TOTAL GROUP LIABILITIES & S'HLDRS EQUITY 68,851 68,198 63,831 62,391 62,448 62,916 64,865

Balance Sheet analysis & drivers

Industrial Net Cash (Debt) (2,414) (2,088) (7,944) (7,191) (7,293) (8,011) (7,168)

Pension 'Debt' (1,144) (1,192) (1,046) (1,046) (1,046) (1,046) (1,046)

Industrial net debt incl pension debt (3,558) (3,280) (8,990) (8,237) (8,339) (9,057) (8,214)

Net Industrial debt/EBITDA 0.7 0.6 3.0 3.5 2.5 2.1 1.3

Gearing -17.3% -15.2% -47.4% -52.0% -45.5% -54.1% -43.0%



8 December 2009 150

Figure 238: Renault Industrial and Group cash flow, 2006A-2012E


Industrial net income 2,603 2,654 556 (2,768) (393) 707 2,154

Industrial depreciation and amortisation 2,835 2,865 2,943 3,325 3,083 3,309 3,438

Industrial share in net income of associates (2,272) (1,668) (431) 1,050 (310) (800) (1,100)

Dividends received from associates 602 936 688 150 0 170 430

Other unrealised income & expenses (487) (185) (644) (500) (200) (200) 0

Gross cash flow 3,281 4,602 3,112 1,258 2,180 3,186 4,922

Decrease/ (increase) in inventories 656 (862) 584 954 (86) (231) (181)

Decrease/ (increase) in auto receivables 51 (171) 283 272 (31) (27) (64)

(Decrease)/ increase in trade payables (522) 1,008 (2,676) 888 275 7 164

Change in other Industrial WC 96 (1) (895) 200 0 0 0

Decrease/ (increase) in Industrial working capital 281 (26) (2,704) 2,314 158 (251) (81)

Industrial operating cash flow 3,562 4,576 408 3,572 2,338 2,934 4,842

Operating cash from Sales Financing (916) 548 41 0 0 0 0

TOTAL GROUP OPERATING cash flow 2,604 4,795 (192) 3,572 2,338 2,934 4,842

...Purchase of intangibles (1,129) (1,347) (1,177) (880) (912) (943) (906)

...Purchase of PPE (net of disposals 2000-2003) (3,340) (3,160) (3,043) (2,539) (2,528) (2,581) (2,682)

Industrial capex (pre-disposals post-2004) (4,469) (4,507) (4,220) (3,420) (3,440) (3,524) (3,588)

Disposals of PPE 884 942 835 600 1,000 0 0

Acquisitions of investments, net of disposals 23 41 (587) 0 0 0 0

Net decrease (increase) in other securities & loans 421 652 97 0 0 0 0

Industrial Cash Flow from Investing (3,141) (2,872) (3,875) (2,820) (2,440) (3,524) (3,588)

Investing cash from Sales Financing 74 (50) (62) 0 0 0 0

TOTAL GROUP INVESTING cash flow (3,044) (2,947) (3,838) (2,820) (2,440) (3,524) (3,588)

Dividends paid to parent company shareholders (664) (995) (1,049) 0 0 (128) (411)

Dividends paid to minority shareholders (22) (22) (60) 0 0 0 0

Capital Increase and other (33) 0 0 0 0 0 0

Industrial cash flows with investors (719) (1,017) (1,167) 0 0 (128) (411)

Net change in financial assets & liabilities (Industrial) 966 (1,765) 2,172 2,295 0 0 0

Industrial cash flow from Financing 247 (2,782) 1,005 2,295 0 (128) (411)

Sales & Financing cash flows from financing (14) (248) (236) (500) (300) (200) (200)

TOTAL GROUP FINANCING cash flow 260 (2,941) 1,494 1,795 (300) (328) (611)

Net change in Industrial cash 668 (1,078) (2,462) 3,048 (102) (718) 843

NET CHANGE IN GROUP CASH (180) (1,093) (2,536) 2,548 (402) (918) 643

Cash flow analysis & drivers

Industrial gross FCF (before WCR) (304) 1,037 (273) (1,562) (260) (339) 1,335

Industrial FCF (23) 1,011 (2,977) 753 (102) (590) 1,254

Industrial depn & amort / sales, % 7.4% 7.5% 8.3% 11.0% 10.0% 10.0% 10.0%

Industrial capex as % of sales 8.7% 8.2% 8.6% 8.4% 8.2% 7.8% 7.8%



8 December 2009 151

Figure 239: RNO unit sales mix by brand YTD 09 Figure 240: RNO revenue mix by division, 2000A-2012E

Renault81%

Dacia14%

Renault Samsung

5%

25,000

27,000

29,000

31,000

33,000

35,000

37,000

39,000

41,000

43,000

2000 2002 2004 2006 2008 2010E 2012E

Automotive Financial Services


Figure 241: RNO WE unit sales by model, YTD 09A Figure 242: RNO EU sales mix 09e vs industry average (%)

Clio25%

Logan6%

Megane23%

Koleos1%

Espace2%

Mascott1%

Modus5%

Sandero2%

Other 1%

Master5%Trafic

5%

Twingo9%Kangoo

9%

Laguna6%

0%5%

10%15%20%25%30%35%40%45%50%

A -

Basi

c

C -

Low

erM

ediu

m

E -

Exec

utiv

e G

Pick

up Van

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

Renault Group Industry avg

0%5%

10%15%20%25%30%35%40%45%50%

A -

Basi

c

C -

Low

erM

ediu

m

E -

Exec

utiv

e G

Pick

up Van

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

Renault Group Industry avg

Source: Company data Source: CSM, Barclays Capital

Figure 243: RNO associate contribution to net income (€mn) Figure 244: RNO EBIT margin by division, 2004A-2015E

(3,000)

(2,000)

(1,000)

0

1,000

2,000

3,000

4,000

2000 2002 2004 2006 2008 2010E 2012E

Nissan Volvo Other RNO Core Contribution to NI

-2%

0%

2%

4%

6%

8%

10%

2004 2006 2008 2010E 2012E 2014E





8 December 2009 152

VOLKSWAGEN – SCALE TO WITHSTAND PRICE WARS

We are initiating coverage of Volkswagen with a 1-Overweight rating for the pref shares and a €85 price target, and with a 2-Equal Weight and €100 price target for the ordinary shares. We believe that VW is the most advanced of the European auto makers in capturing economies of scale – and is likely the world benchmark for modularity – which should give it the cost position to withstand the intense price competition we expect in 2010. Moreover, we do not view the Porsche merger and attendant financial manoeuvring as posing significant downside risk to VW pref holders, as VW appears to have protected itself against an inordinate amount of net debt on Porsche’s balance sheet. We believe any potential ‘overpayment’ for Porsche assets is only at most in the range of €6-7 per VW pref share – small in light of the significant upside potential as VW returns to 4% EBIT margins by 2012 (which would be below our longer-term projections of 6-7% in 2014-15). We value the VW shares based on an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples, which lead us to our €85 price target for prefs and €100 for ords (see the valuation section for further details).

At the same time, we recognize that VW is seen as a consensus overweight – yet has been a stock that has repeatedly punished the consensus trade. Given the erratic movements of Volkswagen’s shares, many investors are loath to enter into a position that could result in substantial losses. These investors should, in our view, consider options as an alternative to the shares, with the benefit that the maximum loss to a long call or put position is the premium paid.


Positives:

Global scale and scope, with leading position in Europe, Brazil and China

Modular strategy to drive additional cost savings while enhancing product differentiation

Continued dominance of German market provides buffer against weak post-scrappage pricing environment

Porsche merger valuation mechanics not as impactful on pref value as market believes

Risks:

Continued selling pressure as Qatar liquidates remaining pref shares

Rights issue in 2010 creates additional supply and selling pressure

Clarity on Porsche merger pricing not likely until 2011

European pricing war undermines profit recovery and stalls margin recovery

Figure 245: VW – headline data and valuation multiples (at current share price), 2008-12E

(€mn) 2008A 2009E 2010E 2011E 2012E

Sales 113808 103,316 102,908 110,631 116,204 EBIT 6,333 2,024 2,339 4,256 5,276 EBIT margin (%) 5.6 2.0 2.3 3.8 4.5 BC EPS € 11.94 1.62 3.96 7.40 9.34 Consensus EPS € 11.94 2.51 3.52 6.54 6.61 Industrial EV/sales (%) 47 70 14 16 13 Industrial EV/EBITDA 4.8x 8.6x 2.2x 2.4x 2.1x P/E ratio – prefs 8.8x 64.8x 26.5x 14.2x 11.3x


VOWG.DE / VOW GY VOWG_p.DE / VOW3 GY

Stock Rating 1-OW prefs / 2-EW ords


Price Target €85.00 prefs / €100.00 ords

Price (04-Dec-2009) €63.50 prefs / €80.39 ords

Potential Upside 34% prefs / 24% ords


8 December 2009 153

Scale drive can offset pricing pressures

While we are concerned about the potential for a pricing war to break out across Europe as scrappage incentives fade, we believe that VW has both the scale, and, importantly, the increased ability to exploit its scale through modularity to improve operating results even with increased price pressures. Moreover, VW’s dominant market position in Germany, and in the C segment across Europe, may give it some ability to resist deep price cutting.

Global scale just the starting point The scale arguments for VW are fairly well known. VW’s dominant European and leading global scale provide the starting point for its strategy. Depending on the sales and production accounting -- whether, for example, to include various distantly-affiliated joint venture subsidiaries -- VW is either the largest or second-largest automaker in the world. VW has either surpassed, or narrowed significantly, the gap to Toyota, albeit due to the hit Toyota has taken in the US market relative to the buoyancy VW enjoyed from the German scrappage programmes.

VW also has, strong emerging market positions, with top 2 ranking in Brazil (21% market share) and number 1 position in China with 11% market share, making it the number one global OEM in terms of total BRIC market share (having 10.6% share vs. GM, the next highest at 9% and RNO-Nissan at 8%).

Figure 246: VW narrowing gap to Toyota in global sales (units in mn)

7.8

6.0

6.1

5.1

5.8

4.0

3.6

3.2

2.4

6.6

6.1

5.2

4.6

4.6

4.3

3.3

3.1

2.4

Toyota

Volkswagen

Renault-Nissan

Ford

General Motors

Hyundai

Honda

PSA

Fiat

2008 2009E



8 December 2009 154

Figure 247: VW ranks first and second by market share in the two largest BRIC countries

Market Share Rank


Porsche-VW Group 20.6% 11.0% 1.4% 4.5% 10.6% 2 2 10 8


Fiat Group 24.9% 0.5% 0.4% 2.6% 5.1% 1 24 12 10

PSA/Mitsubishi 0.0% 0.0% 0.0% 0.0% 0.0% 5 13 14 5

BMW Group 0.1% 0.6% 0.1% 0.7% 0.5% 14 23 16 16

Daimler Group 0.4% 0.4% 0.2% 0.6% 0.4% 11 25 15 21

GM (inc Opel) 19.9% 5.7% 2.5% 12.9% 9.0% 3 5 7 2

Ford Group 10.1% 2.7% 2.3% 6.2% 4.5% 4 15 8 6

Chrysler Group 0.4% 0.2% 0.0% 0.2% 0.2% 10 28 24

Toyota Group 2.9% 7.1% 4.1% 7.9% 6.1% 8 3 5 4

Honda Group 4.0% 5.1% 3.4% 1.9% 4.2% 7 7 6 12


Figure 248: BRIC markets comprise 25% of VW group sales in 2009 and closing the gap on GM by 2012E

41%

30%25%

20% 18% 17% 17%

8% 6% 5%

44%

29% 27%23%

19%21%

18%

11%8% 8%

0%5%

10%15%20%25%30%35%40%45%50%

Renault-Nissan

GM VW Group Honda Ford Toyota Fiat &Chrysler

PSA BMW DaimlerGroup

2009 2012



8 December 2009 155

Figure 249: VW – good geographical breadth, 2009E unit sales

Germany19%

W EU (ex-Germany)

29%

E Europe9%

China18%

Rest of Asia2%

Lat Am13%

Africa & Middle East1%

N Am9%


VW sets benchmark for modularity through its ‘building blocks’ approach Scale is only the starting point for the VW strategy. While VW has had the leading scale in Europe for years, only recently did VW begin to drive greater benefits from its scale. Already, VW is generally acknowledged by competitors to be the furthest advanced in its thinking (along with Toyota) around modularity across platforms and geographies. VW's approach was developed by the current management team while at Audi, and centres around maximum commonality of components across vehicle platforms without compromising brand integrity and vehicle differentiation. The goals are to leverage internal engineering and research and development (ER&D), and simplify the manufacturing processes to allow for greater production flexibility within a plant and across geographies. Moreover, suppliers have similar scale savings, leveraging their engineering and tooling across larger production runs.

VW first used the modular approach at Audi, where the MLB architecture (Modularer Längsmotor-Baukasten, literally, Modular Longitudinal-Motor Building Blocks) was developed to communize all of Audi’s longitudinal (that is, rear-wheeled or all-wheel drive) platforms, from the A4 to the A8, as well as related CUVs (Q5 and Q7).

VW now intends to move the bulk of its volume cars to the MQB architecture (Modularer Querbaukasten, literally, Modular Transverse Building Blocks). MQB will roll out first in 2011 with the new Audi A3. We would expect the MQB platform to include all of VW’s volume (and some smaller premium) offerings in the B, C and D classes (e.g., VW's Fox, Polo, Golf, Jetta, Beetle, Touran, Eos and Passat; Audi's A3 and TT; Skoda's Fabia, Roomster, Octavia and Superb; and Seat's Ibiza, Cordoba, Leon, Altea and Toledo).

Underneath the MQB and MLB are “building blocks” around four major component sets: powertrain, electrical/electronics, suspension and rest of vehicle. Within each are several sets of unique modules (some of which will likely cut across MQB and MLB) that vehicle designers can choose from. While the size of the parts will differ across vehicles, they must conform to a standard geometry, enabling quick design and manufacturing. For example, across all MQB models regardless of size, VW plans to have the same distance from the front wheel axis to the pedals, allowing VW to reduce engine mounting component variants from 18 to 2.


8 December 2009 156

VW already has top-three segment scale in B, C and D. While Nissan-Renault have the largest scale in the B segment, with over 2mn units in 2011, we believe they have little commonality across vehicles. VW, with 1.5mn units, is likely the leader when volume and commonality are considered together.

Figure 250: Global production of major B segment platforms by OEM (000s units) – 2011E

1,460

926

2,103

745

1,1121,215

378

796596

Fiat TYPE 169(500)

Ford B2e(Fiesta)

GM GlobalGamma(Aveo)

Honda GSP(Fit)

Hyundai PB(Accent)

PSA PF1 (207) Renault-Nissan B(Versa)

Toyota NBC-2(Yaris)

VWPQ24/PQ25

(Polo)



VW trails Hyundai only slightly in the C segment, with close to 2mn units in 2011.

Figure 251: Global production of major C segment platforms by OEM (000s units) – 2011E

1,814

1,3011,3721,132

1,946

1,4261,352

1,788

1,369

Fiat TYPE 199(Punto)

Ford C1(Focus)

GM GlobalDelta (Cruze)

Honda C5(Civic)

Hyundai HD(Elantra)

PSA PF2 (308) Renault-Nissan C(Sentra)

Toyota MC-C(Corolla)

VWPQ35/PQ36

(Golf)




8 December 2009 157

As MQB is rolled out, VW has the potential to reach 6mn units on the single platform across B, C and D and related CUV/MPV segments.

In addition, as VW has demonstrated with the Polo mid-cycle reengineering, VW may have opportunities to use common components even before vehicles are completely redesigned.

Overall, MQB could enable roughly 60-70% parts commonality among VW's volume brands. Savings from modularity will help both in ER&D and in ongoing unit costs. Assuming a 10% reduction in upfront costs and 20% in unit costs, VW could save up to €7-10bn from its 2008 baseline costs (well above what we have included in our model). Beyond cost saves, the modular approach can cut time to market by eliminating redesign steps in new vehicles. VW estimates up to one year shorter design cycle – so even if the product cycle remains at 4 -5 years, the vehicle when released will be fresher and more in keeping with contemporary themes as the design lockdown date can be moved closer to the production launch.

Figure 252: Potential additional cost savings through modularity

2009 spend Savings potential % Savings potential €mn

R&D in income statement 5,700 8% 10% 500 600

Engineering 2,900 8% 10% 200 300

Materials 62,300 10% 15% 6,200 9,300

Total 6,900 10,200

Source: Company reports, Barclays Capital

While early in VW volume implementation, some evidence of the potential success of MQB can be seen in the Audi results because Audi led the Group in modularity. As Audi rolled out its MLB platforms, its margins expanded from 4.9% to 8.1%. Audi’s leverage of the MLB platform provides a significant competitive advantage in the premium segment (although we believe BMW will, albeit with lesser scale, leverage modularity across its product lines). While less discussed for brand purposes, modular sharing in upper luxury car sharing is likely to expand as Porsche is integrated.

Figure 253: Increased modularity drove higher Audi margins

5.8%5.3%

4.3% 4.6% 4.9%

6.5%

8.0% 8.1%

5.1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2001 2002 2003 2004 2005 2006 2007 2008 2009E

Audi operating margin



8 December 2009 158

German dominance and C segment focus provides price war buffer In Europe overall VW is a leader in the C segment, with its corporate volume tilted toward C.

Figure 254: VW’s combined share in B & C segments is highest in the industry

0% 5% 10% 15% 20% 25% 30% 35%

VW

PSA

Renault-Nissan

Ford

General Motors

Toyota

Hyundai

Fiat

B C


While we remain concerned about price wars post-scrappage in Europe, beginning in Germany where scrappage programmes first ended, we believe that VW’s dominant position in Germany offers some protection. The German C segment and D segments are among the most concentrated markets in Europe.

Note we measure concentration using the Hehrfindal-Hirschman index (HHI), which is the sum of the squares of the market shares of the participants. An HHI of 10,000 would be a one-layer market (10000 = 100*100 ), while a two-player market with each player at 50% share would have an HHI of 5000 (= 50*50 + 50*50). A market over 1,800 is considered concentrated, while a market over 3,000 is considered highly concentrated.

Figure 255: VW exceeds the Industry average for total sales in the C segment in Europe

0%5%

10%15%20%25%30%35%40%45%50%

A -

Bas

ic

B -

Smal

l

C -

Low

erM

ediu

m

D -

Upp

erM

ediu

m

E -

Exec

utiv

e F G

MPV

Pick

up

SUV

Van

Oth

er

VW group Industry avg



8 December 2009 159

Figure 256: Concentration ratios & degree of concentration by country/segment – volume OEMs

HHI ratios: A B C D E G sports MPV Pickup SUV Van

France 2945 2429 2112 3184 4311 3133 2715 2821 2753 2745

Germany 1343 1359 2483 2655 3528 4263 2211 3176 3021 2152

Italy 3050 2199 1260 2643 9450 3688 1885 2855 2627 2020

Spain 2090 1497 1523 1740 3431 3853 1442 2783 2104 2019

UK 1715 1280 1483 1614 4444 3293 2256 2938 2267 1705

Degree of concentration:

France MEDIUM MEDIUM MEDIUM HIGH HIGH HIGH MEDIUM MEDIUM MEDIUM MEDIUM

Germany LOW LOW MEDIUM MEDIUM HIGH HIGH MEDIUM HIGH HIGH MEDIUM

Italy HIGH MEDIUM LOW MEDIUM HIGH HIGH MEDIUM MEDIUM MEDIUM MEDIUM

Spain MEDIUM LOW LOW LOW HIGH HIGH LOW MEDIUM MEDIUM MEDIUM

UK LOW LOW LOW LOW HIGH HIGH MEDIUM MEDIUM MEDIUM LOW

Note: Concentration ratio = sum of squares of market shares, >1800 considered concentrated, >3000 highly concentrated Source: JD Powers, Barclays Capital analysis

VW dominates the C segment in Germany, with over 50% share in 2009, in part because VW used Golf as a scrappage programme leader. In a more normal year VW still dominates the segment, in 2006, for example, its C share amongst volume players was 44%. VW leads in all other volume segments except for A and MPV.

Figure 257: VW sales by segment as percentage of German volume market sales (%)

Manufacturer A B C D MPV Van Total

VW 4 31 51 41 22 37 35

GM 8 15 12 19 0 5 12

Ford 8 12 9 12 56 9 10

PSA 12 10 5 5 6 15 9

Renault-Nissan 8 6 7 3 8 7 7

Fiat 22 6 1 0 1 11 6

Hyundai 12 4 5 0 3 1 5

Toyota 11 5 4 8 - 0 5

Daimler Group 10 - - - - 14 3

Other 5 11 6 11 5 0 8


Despite the pressures on pricing in Europe and Brazil in 2009, VW has posted positive pricing (in its revenue walk) every quarter in 2009, for a cumulative positive of €600mn year to date. Going forward, we expect that post-scrappage VW will attempt to moderate direct cash incentives, instead using bundled offers and let other fight heavier incentive wars.

Industrial EBIT flat in 2010 but recovering in 2011 and 2012

Given the post-scrappage pressures in 2010, we do not expect a sharp recovery in earnings, with overall operating profit up just €300mn, largely due to improvements in financial services as the credit crisis and residual value issues fade. Across the auto business, we expect the slight improvement in mix to be offset by volume and pricing pressures, currency to continue unfavourable but continue €1.4bn progress on product and fixed-cost reduction as modular strategies are further spread.


8 December 2009 160

We expect cost cutting to continue through 2012, but note that between 2009 and 2012 we have included €4.6bn of cost reduction, conservatively well below the €7-10bn potential described in the prior section. In 2011 and 2012, we expect volumes (ex China) to improve, although we are only modelling a €2,500 per unit operating profit improvement in 2011 and €1,000 in 2012, again leaving room conservatively for pricing pressure.

Figure 258: VW estimated profit walk

€bn 2008 2009E 2010E 2011 2012

Prior year operating profit 6.2 6.3 2.0 2.3 4.3

Volume/price/mix 0.1 -4.1 -0.6 0.7 0.3

Currency -0.8 -1.4 -0.4 -0.2 0.0

Product cost 1.0 0.8 1.0 1.1 0.5

Fixed cost/depreciation 0.1 0.5 0.4 0.2 0.1

Resende sale 0.3 -0.3

Scania -0.2 -0.1 0.0 0.1 0.1

Volkswagen Financial Services -0.1 -0.2 0.2 0.1 0.1

Current year operating profit 6.3 2.0 2.3 4.3 5.3

memo: volume delta units 000 -10 -498 -127 278 293


Porsche merger valuation risks do not detract from value

Despite VW’s strong business operating positions, we believe the trading value is now dominated by near-term technical issues around a potential increase in supply from Qatar Investment Fund sales and future VW fundraising. There is also mid-term uncertainty over the valuation of interim transactions and allocation of shares to Porsche SE holders around the eventual merger of Porsche and VW. However, we believe that there is not significant downside to our €85 price target, even assuming arguendo for stress testing that VW has overpaid for Porsche AG and Porsche Holdings Salzburg, the VW rights issue will be close to current market price, and further assuming that VW shareholders receive an ‘unfairly’ low share of the combined entity.

VW fundraising and Porsche transaction timeline The Porsche-VW transaction timeline, while subject to modification, is becoming increasingly clear. In this quarter, we expect VW to finalize its purchase of 49% of Porsche AG for €3.9bn. In addition, by mid 2010, the market will be asked to absorb up to roughly 90mn additional VW pref shares – up to 25mn from Qatar Holding LLC (whose lock up period expires on 31 December 2009, although it is not clear whether Qatar holds actual shares or options shares, and, if options, if deliverable in physical delivery of shares) and about 65mn from a VW pref issue in 1H10 (assuming €4bn raised at €60 per share). The net result is to almost double the ‘publically held’ pref share count from the 55mn outstanding prior to Qatar’s initial sale to about 170mn – leading, in our view, to much of the recent weakness in VW prefs.


8 December 2009 161

Figure 259: Merger timeline

Date Event

2009

3 December 2009 Announcement of DAX official ranking as of 30 Nov

3 December 2009 VW EGM gave authorisation for VW pref share issuance

18 December 2009 Qatar option expiry on VW ords

31 December 2009 Expiry of Qatar lock-up period on VW prefs

by 31 December 2009 Purchase of 49% of Porsche AG by VW for €3.9bn

2010

11 March 2010 VW FY09 results

sometime in 1H10 Potential VW pref issue (est €4bn, window likely 11 Mar-15 May)

2011

sometime in 1H11 VW purchases Porsche Holding Salzburg for €3.55 EV

sometime in 1H11 Porsche SE capital increase (est. €5bn)

sometime in 2011 Porsche SE merges into VW AG


We expect the VW pref issue at some point following the 2009 results announcement on 11 March.

Before the merger, VW is to purchase two assets – 49% of Porsche SE (for €3.9bn, paid to Porsche AG) and Porsche Holdings Salzburg (for €3.55bn, paid to family shareholders of the auto dealer). Porsche would also pursue a capital increase of about €5bn, likely timed after Porsche/Piech family members receive the proceeds from the Salzburg sale. After the capital increase, Porsche SE (which at that time owns half of Porsche AG and its VW ord shares but has largely paid down its debt) merges into VW AG, with Porsche ord shareholders largely receiving VW ords and Porsche prefs receiving VW prefs (although merger details could vary).

Hypothetical overpayment and dilution would not detract from €85 target value In terms of risks to valuation from these transactions, we start with the value of the core operating businesses of both VW and Porsche (as this will likely form the basis for the future IDW S-1 valuation), and add in ‘external’ affiliates (ie, MAN) and subtract net debt. For purposes of this exercise, we have chosen a low adjusted EV/EBITDA multiple for VW (2.5 x vs historical average of 3.5x) for the industrial business. For Porsche, we assume 6.0x for a gross operating enterprise value of €10bn (note that this is somewhat below the €12.4bn VW pegged the value of Porsche SE at; again, we have chosen to be conservative as this would imply that VW ‘overpaid’ for Porsche SE).

Step 1: Value of stand-alone operating firms

Adjusting for VW's cash balance, and including the value of financial services and MAN leads to an enterprise value of €44bn for VW, or €95 per pref share (at a 20% discount), before giving effect to VW’s purchases of Porsche-related assets.


8 December 2009 162

Figure 260: Value of VW & Porsche operating businesses

€mn VW Porsche

Starting point – operating businesses and 'external' affiliates

2011 EBTIDA 11,469 1,765

EV/EBITDA multiple 2.5x 6.0x

Core auto operations 28,671 10,590

Financial services 9,372 239

"External" associates (ie, MAN) -2,396

Gross value of operating firm and external aff. 35,647 10,828

less debt

Net debt (cash) -18,840 11,400

Minorities 1,905

Hybrid liabilities 1,020

Pension (after tax) 8,495 -431



per ord € 119

per pref € 95

at discount of 20%


Step 2: Giving effect to VW purchase of Porsche related assets

One investor concern is that VW, in an attempt to gain Porsche family buy-in to the merger, agreed to overpay for the initial stake in Porsche SE (which provides cash to pay down Porsche net debt) and for control of Porsche Holding Salzburg (which will provide cash to the families to use to subscribe to Porsche fund raising). Even assuming VW overpaid for Porsche SE by €1.25bn (as the €12.4bn paid for a 49% equity stake would imply a EV/EBITDA of 7.6x vs our assumption of 6.0x) and by Salzburg by 1.5bn (with no public financials we have arbitrarily assumed an overpayment), pref value per share would still be €90.

Also note that at this point, Porsche as an operating company has negative value, with more than 100% of the value of Porsche shares attributable to its holdings in VW.


8 December 2009 163

Figure 261: VW purchase of Porsche assets

€mn VW Porsche


€ per share € 108 -€ 7

Plus intra-group transactions

VW minority in Porsche AG:

Value of equity business interest 3,038 -3,038

Cash received/(paid) -3,900 3,900

Debt (assumed)/shed

Memo: value creation (dilution) -862 862

VW purchase of Porsche Salzburg

Value of business interest 2,000

Cash received/(paid) -3,500

Memo: value creation (dilution) -1,500

Value after sales to VW (ex cross-holdings) 41,724 -298 Value of Porsche AG stake in VW 15,325

Net value of firms before fund raise 41,724 15,027

€ per share € 102 € 86

€ per ord € 112

€ per pref € 90 at discount of (%) 20


Step 3: Giving effect to potential dilution from fund raising

Another investor concern is around dilution around the planned pref offering in 1H10, in our view. We believe that VW will seek to raise about €4bn, that is, enough to fund the initial Porsche purchase for €3.9bn (although the EGM has authorized up to 135 mn additional shares). While there is some possibility VW postpones any offering, nevertheless we assume that €4bn is raised at €50 per share, for an issuance of 80mn new pref shares. The resulting dilution would be €8 per pref share, while still leaving value at €82 per share.

Figure 262: Effects of fund raising

€mn VW Porsche

Value after sales to VW (ex cross-holdings) 41,724 -298

Fund raising 4,000 5,000

Shares issued 80 125

€ price per share € 50 € 40

New share count 488 300

Value of firms after fund raise (ex cross-holdings) 45,724 4,702Value of Porsche AG stake in VW 14,041

Net value of firms after fund raise 45,724 18,743

€ per share € 94 € 62 € per ord € 103

€ per pref € 82

at discount of (%) 20



8 December 2009 164

Step 4: Potential risk from relative IDW S1 relative valuations

Finally, we think investors are concerned that VW pref shareholders will wind up with less of the merged company than what they could consider their fair share. At our base case valuations, Porsche shareholders would receive 37% of the economic value of the merged entity and VW shareholders 63% (roughly in line with ingoing ownership). Even assuming, however, that Porsche shareholders get 45% of the combined firm, and that VW is arbitrarily undervalued, and Porsche SE is overvalued by a factor of 3x, would only dilute VW pref value to €72 – in part because any undervaluation of VW shares detracts from Porsche share value.

Figure 263: Merger allocation options

VW Porsche

Who brought what to the table:

VW shareholders ex Porsche and after capital raise 31,683


Core business 4,702

VW stake 14,041

Total 31,683 18,743 % of newco 63 37

€ per share € 94 € 62

€ per ord € 103

€ per pref € 82


What if "unfair"



Core business 10,400

VW stake 12,291

Total 27,734 22,692 % of newco 55 45

€ per share € 82 € 76

€ per ord € 90

€ per pref € 72



Rating We are initiating coverage of Volkswagen with a 1-Overweight rating for the preference shares and an €85 price target, with a 2-Equal Weight and €100 price target for the ordinary shares. We believe that VW is the most advanced of the European auto makers in capturing economies of scale – and is likely the world benchmark for modularity – which should give it the cost position to withstand the intense price competition we see in 2010. Moreover, we do not view the Porsche merger and attendant financial manoeuvring as posing significant downside risk to VW pref holders, as VW appears to have protected itself against an inordinate amount of net debt on Porsche’s balance sheet. Any ‘overpayment’ for Porsche assets is only at most around €6-7 per VW pref share – small in light of the large upside as VW returns to 4% EBIT margins by 2012 (which would be below our longer-term projections of 6-7% in 2014-15).


8 December 2009 165

Valuation methodology We value the VW preference share based on an average of EV/sales and PE metrics at historical and peer average multiples: We value the VW ords using a 20% premium to the pref shares.

EV/sales

VW prefs have historically traded at an eight-year average of 40% industrial EV/industrial sales, although rose to 66% as sales dipped in 2009. At current market price the shares are only trading at 14% 2010E EV/sales on our estimates. We believe that the current VW pref share price significantly undervalues the share based on this valuation metric, especially as we remain only just above consensus on our top-line estimates for 2010E.

Figure 264: Slightly above consensus revenue & earnings estimates


Revenue (€mn) 102,908 102,437 0.5%

EPS (€) 3.96 3.63 9.2%


We believe that VW should trade at least at 25%, still well below the 2001-05 range, implying a value of €90 for the prefs and €105 for the ords.

Figure 265: At current price VW appears undervalued on EV/sales metrics

0%

10%

20%

30%

40%

50%

60%

70%

2001A 2003 2005 2007 2009E 2011E 2013E 2015E

Historical average Industrial EV/Sales

Source: Company Data and Barclays Capital

EV/EBITDA

Historically VW has traded at an eight-year average of 3.5x adjusted EV to industrial EBITDA (vs 3.4x for the sector as a whole). Looking out to 2011E, when we expect auto markets to have normalised to a greater degree, our estimates put VW at only 1.3x at the current share price. Recognising some of the risks inherent in the merger and future dilution, we conservatively believe that the company should trade at 1.7x, from which we derive a share price of €80 for the prefs and €95 for the ords.


8 December 2009 166

Figure 266: VW has historically traded around 3.5x EV/EBITDA

0

2

4

6

8

10

2001A 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E

Adjusted EV/EBITDA Historical average


An average of both these valuation metrics leads us to set a €85 price target for the preference shares and €100 for the ordinary shares.

Inherent in our valuation is a 20% spread between the prefs and the ords, which is below the historical 35% discount. With the pref shares becoming the primary trading vehicle going forward, following likely DAX inclusion, as well as limited effective voting rights for the surviving public ord shares, we believe the discount should narrow.

Figure 267: VW key valuation metrics

2006 2007 2008 2009E 2010E 2011E 2012E




Industrial EV/ EBIT 6.1x 4.5x 3.8x 7.4x 1.2x 1.3x 1.1x

P/E 34.4x 11.4x 9.0x 74.0x 10.1x 4.9x 3.3x

FCF yield (%) 17.7x 10.1x 8.8x 64.8x 26.5x 14.2x 11.3x

Price/Sales (%) 7.9 5.3 2.4 5.0 6.2 7.1 2.9

Price/Book 66 72 55 85 33 31 29


Valuation multiples at €85/€100 price target



Industrial EV/ EBIT 6.1x 4.5x 3.8x 2.9x 1.8x 1.7x 1.5x

P/E 34.4x 11.4x 9.0x 40.9x 24.2x 9.9x 7.6x

FCF yield (%) 17.7x 10.1x 8.8x 52.3x 22.7x 10.8x 9.1x

Price/Sales (%) 7.9 5.3 2.4 12.4 4.9 6.1 2.4

Price/Book 66 72 55 36 40 34 34




8 December 2009 167

Figure 268: After peaking at -90% Nov 08, the pref ord discount has narrowed to 36%

-100%-90%-80%-70%-60%-50%

-40%-30%-20%-10%

0%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

VW historical pref discount Historical average

Source: Datastream, Barclays Capital


External risk – macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

Risks from financial transactions – VW plans to issue future equity, purchase assets from Porsche and Porsche family companies, and complete a merger of Porsche AG into VW AG. The pricing and terms for the equity issuance and future merger are not known at this point, and may be set in a way that prejudices owners of VW pref or ord shares.

Risks around pref/ord discount: the pref to ord discount has been volatile, dipping as low as 90% -- any return to ‘abnormal’ discount levels would put our pref target at risk.


8 December 2009 168

VW preferred shares expected to replace VW ordinary shares as a member of the DAX if Qatar exercises Dec09 options If Qatar exercises its Dec09 expiry call options on Volkswagen’s ordinary shares, we understand that the ordinary share free float would be considered by Deutsche Boerse to be less than 10% of the market cap and therefore subject to the fast-exit rule. Under this rule VW ordinary shares would exit membership of the DAX, usually two trading days after the announcement, and VW preferred shares (as they are the top member of November’s selection list) would replace them. As a large number of index trackers would have to buy the preferred shares, the preferred are likely to rise during a membership change.

Qatar could roll the Dec09 options to a later expiry

While we believe VW preferred shares are likely to rise once Qatar exercises its Dec09 options, a long position in the preferred shares has the disadvantage of being fully exposed to any event that weighs on the share price. For instance should Qatar roll its call option position to a later expiry, or if Qatar disposes of its remaining VW preferred share stake after the 31 December 2009 lock-up expires, we see potential downside to the preferred shares. Additionally the planned issue of new preferred shares could weigh on the share price.

Figure 269: Profit and loss of Volkswagen preferred Jan10 €64 call at expiry

-5

0

5

10

15

40 50 60 70 80

Stock price

P&L at expiration


VW pref Jan10 €64 (99%) call is a lower-risk alternative to shares Given the erratic movements of Volkswagen’s shares many investors seem loath to enter into a position which could result in substantial losses. These investors should, in our view, consider options (with equal notional) as an alternative to the shares, with the benefit that the maximum loss to a long call or put position is the premium paid. January at-the-money (ATM) call options on VW preferred shares can currently be bought for an implied volatility of 50%, a discount to the current 61% three-month realised volatility. The arguably low implied volatility and the short-dated January expiry results in a low premium cost to the investor. Such a position benefits from offering exposure to any upside in the preferred shares, but losses are capped at the relatively low premium. As we have a €85 target price on the VW preferred shares, we see substantial upside to the strategy.

VW preferred share Jan10 €64 call indicative offer: € 4.4 (6.8%), ref €64.4, delta 55%

Colin Bennett +44 (0)20 777 38332


Arnaud Joubert

+44 (0)20 777 48344 [email protected]


Abhinandan Deb +44 (0)20 777 32481


Anshul Gupta

+44 (0)20 313 48112 [email protected]


The arguably low implied volatility and the short-dated

January expiry results in a low premium cost to the investor


8 December 2009 169

Credit perspective Barclays Capital credit analysts, Rob Perry and Darren Hook, currently rate Volkswagen Overweight. While flexibility in VW's low A rating is limited, plans to execute the Porsche merger as a 2-stage process, deleverage Porsche SE prior to the merger, and fund the acquisition with the issuance of preference shares illustrates its commitment to a low A rating, in their view. While VW will face headwinds from the expiry of incentives in Germany next year, they believe that importantly, VW will still generate significant free cash flow.


8 December 2009 170

Figure 270: Volkswagen Group and Automotive income statement, 2006A-2012E


Group Income Statement:

Sales revenue 104,875 108,897 113,808 106,533 106,170 116,866 124,899

Cost of sales 91,020 92,603 96,612 92,178 90,032 99,102 105,914

Gross profit 13855 16294 17196 14,355 16,138 17,764 18,985

Gross margin % 13.2% 15.0% 15.1% 13.5% 15.2% 15.2% 15.2%

SG&A 11,492 11,727 13,294 12,960 12,210 13,440 14,363

Other operating expense (income) 354 (1,584) (2,431) (2,094) 374 (1,154) (2,321)

Operating profit 2,009 6,151 6,333 3,431 3,555 5,478 6,942

Operating margin % 1.9% 5.6% 5.6% 3.2% 3.3% 4.7% 5.6%

Equity income 734 910 614 281 375 500

Other financial result -342 -635 -1,409 -994 -1,121 -1,259

Financial result -216 392 275 -795 -712 -745 -759

Profit before tax 1,793 6,543 6,608 2,636 3,124 5,108 6,683

Income tax expense (162) 2,421 1,920 930 923 1,505 1,967

Tax rate % -9% 37% 29% 35% 30% 29% 29%

Profit after tax 1,955 4,122 4,688 1,707 2,201 3,603 4,716

Minority interest -1 -2 65 -37 -68 -82 -96

Net profit attributable to shareholders 1,954 4,120 4,753 1,670 2,133 3,521 4,620

Earnings per ord share € 5.03 € 10.43 € 11.92 € 4.18 € 5.31 € 8.67 € 11.27

Diluted earnings per ord share € 5.00 € 10.49 € 11.98 € 4.18 € 5.31 € 8.67 € 11.27

Earnings per pref share € 5.07 € 10.34 € 11.88 € 4.17 € 5.29 € 8.64 € 11.23

Ordinary Dividend € 1.80 € 1.93 € 1.30 € 1.35 € 1.90 € 2.00 € 2.10

Preferred Dividend € 1.86 € 1.99 € 1.36 € 1.41 € 1.96 € 2.06 € 2.16

Number of Shares 388 394 398 400 404 408 412

Automotive Income Statement:

Sales revenue 96,004 98,752 102,632 94,485 94,299 104,402 111,811

Gross profit 12,169 14,078 14,737 12,016 12,839 15,871 18,132

Automotive gross margin % 12.7% 14.3% 14.4% 12.7% 13.6% 15.2% 16.2%

SG&A 10,476 10,751 12,315 11,887 10,844 12,006 12,858

Other operating expense (income) 46 1,867 3,006 -2,271 500 500 500

Operating profit 1,739 5,194 5,428 2,400 2,495 4,365 5,774

Automotive operating margin % 1.8% 5.3% 5.3% 2.5% 2.6% 4.2% 5.2%

Equity income 580 809 527 201 275 400

Other financial result -300 -560 -1,219 -590 -601 -612

Financial result -392 280 249 -692 -389 -326 -212

Automotive Profit before tax 1,347 5,474 5,677 1,708 2,106 4,040 5,562

Income tax expense -513 -2,254 -1,668 -501 -618 -1,184 -1,631

Auto tax rate 38% 41% 29% 29% 29% 29% 29%

Automotive Profit after tax 834 3,220 4,009 1,207 1,489 2,855 3,931

Memo:

Automotive EBITDA 9,501 12,623 12,108 9,571 11,503 12,196 13,969

EBITDA margin % 9.9% 12.8% 11.8% 10.1% 12.2% 11.7% 12.5%



8 December 2009 171

Figure 271: VW Group Revenues, Unit Sales, Production and EBIT by division, 2006-2012E


Revenue by Division

Volkswagen 70,710 73,944 72,928 66,476 65,760 73,704 77,217

Audi 31,720 33,617 34,196 30,024 30,969 34,832 38,861

Skoda 7,186 8,004 8,039 7,269 6,840 7,319 8,136

SEAT 5,874 5,899 5,196 4,511 3,901 3,738 4,133

Bentley 1,340 1,376 1,084 479 483 705 862

Commercial Vehicles 8,092 9,297 9,607 5,296 5,960 6,139 6,323

Scania NA NA 3,865 6,139 5,579 5,858 6,151

Remaining Companies and Other -28,918 -33,385 -32,036 -25,341 -25,193 -27,892 -29,872

Automotive Revenues 96,004 98,752 102,879 94,853 94,299 104,402 111,811

Unit sales by division (units 000s)

Volkswagen 3,451 3,664 3,648 3,490 3,289 3,687 3,863

Audi 1,139 1,200 1,275 1,164 1,155 1,299 1,449

Skoda 562 620 626 566 533 570 634

SEAT 419 411 375 322 282 270 298

Bentley 10 10 8 4 4 5 6

Commercial Vehicles 388 427 439 267 272 281 289

Scania NA NA 31 43 45 47 49

Volkswagen China 694 930 989 1,195 1,315 1,446 1,591

Group Auto Unit Sales 5,026 5,262 5,252 4,930 4,607 5,138 5,517

Group Unit sales 5,720 6,192 6,272 6,167 5,966 6,631 7,156

Memo: Total Unit Production 5,660 6,213 6,347 NA NA NA NA

Operating Income by Division:

Volkswagen 918 1,940 2,715 1,387 1,280 2,471 2,998

Audi 2,054 2,705 2,772 1,879 2,021 2,600 3,204

Skoda 515 712 565 335 271 343 465

SEAT -159 8 -78 -228 -319 -344 -285

Bentley 137 155 10 -228 -228 -194 -171

Commercial Vehicles 138 305 375 -113 -13 13 41

Scania NA NA 417 168 84 126 170

Remaining Companies and other -63 -631 -1,336 -800 -600 -650 -650

Automotive Operating Income 4,383 5,194 5,440 2,400 2,495 4,365 5,774

Financial Services 843 957 905 916 1,060 1,113 1,168

Group Operating income 5,226 6,151 6,345 3,317 3,555 5,478 6,942

Operating margin

Volkswagen 1.3% 2.6% 3.7% 2.1% 1.9% 3.4% 3.9%

Audi 6.5% 8.0% 8.1% 6.3% 6.5% 7.5% 8.2%

Skoda 7.2% 8.9% 7.0% 4.6% 4.0% 4.7% 5.7%

SEAT -2.7% 0.1% -1.5% -5.1% -8.2% -9.2% -6.9%

Bentley 10.2% 11.3% 0.9% -47.6% -47.2% -27.6% -19.8%

Commercial Vehicles 1.7% 3.3% 3.9% -2.1% -0.2% 0.2% 0.6%

Scania NA NA 10.8% 2.7% 1.5% 2.2% 2.8%

Financial Services 1.3% 1.4% 1.2% 1.2% 1.2% 1.2% 1.2%

Automotive Operating Margin 4.6% 5.3% 5.3% 2.5% 2.6% 4.2% 5.2%



8 December 2009 172

Figure 272: VW Automotive balance sheet, 2006-2012E


Intangible assets 7110 6736 12186 13,433 15,790 18,400 21,195

PPE 20148 19151 22879 22,600 19,805 18,852 18,024

Leasing and rental assets 61 75 410 313 263 213 163

Financial services receivables 322 0 0 0 0

Noncurrent investments and other 10176 11602 10903 11,002 11,002 11,002 11,002

Total Noncurrent assets 37817 37564 46378 47,348 46,860 48,468 50,384

Inventories 12377 13319 6732 14,561 14,452 14,654 16,145

Financial services receivables 179 231 -103 -88 -88 -88 -88

Current receivables and other 8571 10002 13340 12,843 8,342 15,112 10,007

Marketable securities 5024 6503 3730 3,684 3,584 3,484 3,384

Cash 8117 9135 7664 20,336 16,996 21,394 21,901

Assets held for sale 1007

Total Current assets 34268 39190 42370 51,335 43,286 54,556 51,349

Total assets 72085 76754 88748 98,683 90,146 103,024 101,733

Equity 20774 24802 28964 30,238 31,727 34,582 38,513

Equity attributable to shareholders 20719 24739 26841 28,333 29,822 32,677 36,608

Minority interests 55 63 2123 1,905 1,905 1,905 1,905

Noncurrent financial liabilities 4539 3645 2240 10,084 5,240 5,240 5,240

Provisions for pensions 13719 12481 12829 13,959 14,059 14,159 14,259

Other noncurrent liabilities 10603 12383 15619 15,642 17,206 18,927 20,820

Total Noncurrent liabilities 28861 28509 30688 39,685 36,505 38,326 40,319

Current financial liabilities 1759 -1139 2865 -46 -46 -46 -46

Trade payables 7288 8202 9085 11,234 4,388 12,590 5,376

Other current liabilities 13403 16380 16380 17,570 17,570 17,570 17,570

Liabilities held for sale 766

Current liabilities 22450 23443 29096 28,758 21,912 30,114 22,900

Total liabilities 51311 51952 59784 68,443 58,417 68,440 63,218

Total equity and liabilities 72085 76754 88748 98,681 90,144 103,022 101,731



8 December 2009 173

Figure 273: VW Automotive cash flow, 2006-2012E


Cash flow

Profit before tax 774 5,474 5,677 2,083 2,106 4,040 5,562

Income taxes paid -742 -1,290 -1,973 -587 -618 -1,184 -1,631

Depreciation 7,762 7,429 6,680 7,170 9,008 7,831 8,196

Change in pension 246 99 132 131 100 100 100

Other noncash income/expense -384 190 591 -199

Gross cash flow 7,656 11,902 11,107 8,598 10,597 10,786 12,227

Change in working capital 4,089 1,773 -2,336 4,070 -672 2,951 -1,707

Inventory -118 -1,219 -2,688 2,517 109 -202 -1,491

Receivables 701 -555 -1,130 -1,947 4,500 -6,770 5,105

Liabilities 431 2,092 1,100 2,926 -6,846 8,202 -7,215

Change in other provisions 3,075 1,455 382 573 1,564 1,721 1,893

Cash flow from operations 11,745 13,675 8,771 12,668 9,925 13,737 10,519

Acquisition of PPE -3,644 -4,555 -6,762 -5,178 -6,213 -6,879 -7,367

Capitalized development costs -1,478 -1,446 -2,216 -2,166 -2,357 -2,610 -2,795

Change in leasing and rental assets -50 -80 -277 -197 50 50 50

Change in financial services receivables -114 251 297 -15 0 0 0

Acq and disposal of equity interests -1,040 -869 -2,571 0 0

Other -2,892 -2,519 2,311 79 0 0 0

Cash flow from investing -9,218 -9,218 -9,218 -7,477 -8,520 -9,439 -10,112

Net cash flow (CF from ops and CF from investing) 2,527 4,457 -447 5,191 1,404 4,298 407

Change in investments in securities -998 -2,020 496 1,590 100 100 100

Cash flow from financing -3,650 -4,204 942 4,328 -4,844 0 0

Exchange rate, etc. -51 -81 -57 160 0 0 0

Change in auto cash -2,172 -1,848 934 11,269 -3,340 4,398 507

Automotive cash at EOP 8,117 8,937 7,639 20,336 16,996 21,394 21,901

Securities and loans 5,314 7,047 5,679 3,684 3,584 3,484 3,384

Gross automotive liquidity 13,431 15,984 13,318 24,020 20,580 24,878 25,285

Total third-party borrowings -6,298 -2,506 -5,279 -10,038 -5,194 -5,194 -5,194

Net automotive liquidity 7,133 13,478 8,039 13,982 15,386 19,684 20,091



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Valuation Methodology and Risks

European Autos & Auto Parts

BMW (BMW GY / BMWG.DE)

Valuation Methodology: We value the BMW share based on an average of EV/Sales and PE metrics at historical and peer average multiples. BMW has historically traded at a 5-year average EV/Sales of 39%, although it dipped to 20% during the credit crisis of 2008 and at current market price is only trading at 18% 2010E EV/Sales on our estimates. By comparison, peer Daimler's historical average is 42% and on our estimates is currently trading at 44% 2010 EV/Sales. We believe that the current BMW share price significantly undervalues the share based on this valuation metric. Using its own historical average of 39% implies BMW should trade at €50/share. Secondly, historically BMW has traded at an average 11x PE (vs 13x at Daimler). Looking out to 2011E, when we expect autos markets to have normalised to a greater degree, our above consensus EBIT estimates put BMW at only 10x at the current share price. We believe the company should trade at its historical level of 11x, from which we derive a price of €35. We take a weighted average of both these valuation metrics lead us to set a €41 price target for the share.

Risks which May Impede the Achievement of the Price Target: The main risks to our price target, in our view, are: 1) external risk - macroeconomic factors outside the control of hte ocmpany, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve; 2) risks to leasing book - we believe that the worst is now behind the company is relation to writedowns on its financial services leasing book but were second-hand prices to fall significantly and cause further writedowns to residual values, BMW's larger than average financial services penetration would result in greater downside risk than for peers.

Daimler AG (DAI GY / DAIGn.DE)

Valuation Methodology: We value Daimler using a SotP methodology but we acknowledge that this assumes the market gives full credit to each constituent part of the company. In reality we have seen that Daimler has tended to trade much closer to BMW multiples, despite its supposedly higher-rated truck division historically comprising 25% of earnings. We therefore cross-check our valuation against historical and peer average EV/sales estimated multiples and use a weighted average of the both methodologies to derive our target price.

1. SotP - using a sum-of-the-parts valuation we arrive at a €33 price for Daimler, implying 7% downside to its current market price. We base our calculation on a blended average of peer EV/sales and PE multiples for the core Autos business, peer EV/sales and EV/EBIT multiples for Daimler Trucks and bring in Finance companies and Vans & Buses divisions at historical average multiples. We also apply a 5% discount to the SotP valuation to take account of the historical holding discount for the trucks business.

2. EV/sales: Daimler has traded at a five-year historical median of 42% industrial EV/sales although during that period has ranged from a low of 13% in 2003 (incl Chrysler) to a high of 57% in 2007. On the same time frame, BMW has traded at a median average EV/sales of 39% and has ranged from 20% to 59%. Applying Daimler’s own historical average multiple would imply a price of €31.

A weighted average of both these valuation metrics leads us to set a €32 price target for the share.

Risks which May Impede the Achievement of the Price Target: The main upside risks to our price target, in our view, are:

1) external risk - macroeconomic factors ouside the control of the company, leading to a strong demand and pricing environment than we currently assume, could mean that the company exceeds our forecasts

2) were truck markets to improve faster than consensus (and our) estimates assume, this would provide upside to the current share price

3) currency risk - if USD and GBP rates were to improve significantly against the euro, this would ease the FX burden for Mecedes' earnings forecasts.

Fiat SpA (F IM / FIA.MI)

Valuation Methodology: We value the Fiat share based on EV/sales and EV/EBITDA metrics against Fiat’s historical trading range, with a reference to the SotP methodology based on peer multiples for the various divisions to confirm our valuation.

1) EV/sales: Fiat has historically traded at a six-year historical average of 28% EV/sales. But at current market price is trading at 35% 2010E EV/sales on our estimates, highlighting our belief that the share is significantly overvalued at present. The OEM sector average range is 27%. At our €8 target price, Fiat would trade at 28% EV/sales, exactly in line with its historical average. 2) EV/EBITDA: our EV/EBITDA looks at adjusted industrial EV (backing out financial services) over industrial EBITDA. Historically, Fiat has traded at a 6-year average of 4.3x EV/EBITDA. Looking out to 2011E our below consensus EBITDA estimates put Fiat at a 4.1x current share price. However, given the 2010 headwinds we believe this discount is justified, and our target is based on 4x 2011 EBITDA from which we derive our €8 target price.

Risks which May Impede the Achievement of the Price Target: The main upside risks to our price target, in our view, are:

1) risks to our commonality assumptions - if there were to be a more rapid turnaround at Chrysler than we currently forecast

2) a more rapid turnaround in truck and/or agricultural equipment than we assume in our forecasts could provide further upside to the share

Peugeot SA (UG FP / PEUP.PA)

Valuation Methodology: We value PSA using a combination of a Sum of the Parts methodology and historical and peer average EV/EBITDA multiples:

1. SotP: Using a sum-of-the-parts valuation we arrive at a value of €27/share for Peugeot, implying 12% upside to its current market price. We base our calculation on a blended average of peer EV/Sales and EV/EBITDA multiples for the core Autos business and bring in Finance companies, GEFCO and Faurecia at historical average multiples. We apply a 5% discount to the NAV in line with the average discount that the market has historically applied when using the SotP methodology.

2) Group EV/EBITDA


8 December 2009 175


multiples: historically PSA has traded at an 8-year average of 2.4x EV/EBITDA at a group level (vs 6x at RNO and 2.7x for the sector as a whole). Our slightly below consensus EBITDA estimates put PSA at 2.5x at current share price in 2010E, just ahead of its historical average. We believe that the company should trade closer to its historical level of 2.4x, which would imply a share price of €23.

A blended average of both these valuation metrics leads us to set a €26 price target for the share.

Risks which May Impede the Achievement of the Price Target: The main downside risks to our price target, in our view, are:

Macroeconomic risks - macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

1) Liquidity risk – current high gearing levels and lack of investment grade credit rating expose the share to balance sheet risk, especially were the Peugeot to finance any future alliance with Mitsubishi Motors with debt

2) M&A risk – if PSA were to embark on any further strategic alliances or seek to restructure its holding in Faurecia, this could provide further upside to the share and cause it to exceed our current target price.

Renault SA (RNO FP / RENA.PA)

Valuation Methodology: Valuation Methodology

We value the RNO share using a SotP methodology which we confirm against historical and peer average EV/EBITDA multiples to reach our €42 target price:

1. SotP - using a sum-of-the-parts valuation we arrive at a €42 target price for Renault. We base our calculation on a blended average of peer Industrial EV/sales and Industrial EV/EBITDA multiples for the core Autos business and bring in associates at market value. However, we also apply a 10% discount to the NAV in line with the average discount that the market has historically applied.

2. EV/EBITDA - we also cross-check our SotP calculation against peer and historical average multiples. Historically RNO has traded at an 8-year average of 6x unadjusted (ie, pre-associate stake) EV/EBITDA (vs 2.4x at PSA and 3.4x for the sector as a whole). Looking out to 2011E, when we expect autos markets to have normalised to a greater degree, our above consensus EBITDA estimates put RNO at only 4.5x at current share price. We believe that the company should trade closer to its historical level of 6x, which would imply a value of €43/share.

We give a greater weight to our SotP valuation, thus on a weighted average combination of both these valuation metrics we derive a €42 price target for the share.

Risks which May Impede the Achievement of the Price Target: The main downside risks to our price target, in our view, are:

1)Risks to our cost commonality assumptions, ie, under-delivery on expected alliance savings

2) Current high gearing levels add risk to share

3) With more than 60% of earnings generated by Nissan (>70% by total associate contribution) any significant downturn in either Nissan or Volvo’s earnings stream would have a major knock-on affect on Renault’s own bottom line.

Volkswagen AG (VOW GY / VOWG.DE)

Valuation Methodology: We value the VW preference share based on an average of EV/sales and PE metrics at historical and peer average multiples and then set a 20% discount to value the ordinary shares. An average of both these valuation metrics leads us to set a €85 price target for the preference shares and thus €100 for the ordinary shares. This 20% spread between the prefs and the ords, is below the historical 35% discount but with the pref shares becoming the primary trading vehicle going forward, following likely DAX inclusion, as well as limited effective voting rights for the surviving public ord shares, we believe the discount should narrow. Our two valuation methodologies are:

1) EV/sales - VW prefs have historically traded at an eight-year average of 40% industrial EV/industrial sales, although rose to 66% as sales dipped in 2009. At current market price the shares are only trading at 14% 2010E EV/sales on our estimates. We believe that the current VW pref share price significantly undervalues the share based on this valuation metric, especially as we remain only just above consensus on our top-line estimates for 2010E.

We believe that VW should trade at least at 25%, still well below the 2001-05 range, implying a value of €90 for the prefs and €105 for the ords.

2) EV/EBITDA - Historically VW has traded at an eight-year average of 3.5x adjusted EV to industrial EBITDA (vs 3.4x for the sector as a whole). Looking out to 2011E, when we expect auto markets to have normalised to a greater degree, our estimates put VW at only 1.3x at the current share price. Recognising some of the risks inherent in the merger and future dilution, we conservatively believe that the company should trade at 1.7x, from which we derive a share price of €80 for the prefs and €95 for the ords.

An average of both these valuation metrics leads us to set a €85 price target for the preference shares and €100 for the ordinary shares.

Risks which May Impede the Achievement of the Price Target: The main risks to our price target, in our view, are:

1) External risk – macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

2) Risks from financial transactions – VW plans to issue future equity, purchase assets from Porsche and Porsche family companies, and complete a merger of Porsche AG into VW AG. The pricing and terms for the equity issuance and future merger are not known at this point, and may be set in a way that prejudices owners of VW pref or ord shares.

3) Risks around pref/ord discount: the pref to ord discount has been volatile, dipping as low as 90% -- any return to 'abnormal’ discount levels would put our pref target at risk.


8 December 2009 176


Volkswagen AG-PFD Preferred (VOW3 GY / VOWG_p.DE)

Valuation Methodology: We value the VW preference share based on an average of EV/sales and PE metrics at historical and peer average multiples:

1) EV/sales - VW prefs have historically traded at an eight-year average of 40% industrial EV/industrial sales, although rose to 66% as sales dipped in 2009. At current market price the shares are only trading at 14% 2010E EV/sales on our estimates. We believe that the current VW pref share price significantly undervalues the share based on this valuation metric, especially as we remain only just above consensus on our top-line estimates for 2010E.

We believe that VW should trade at least at 25%, still well below the 2001-05 range, implying a value of €90 for the prefs.

2) EV/EBITDA - historically VW has traded at an eight-year average of 3.5x adjusted EV to industrial EBITDA (vs 3.4x for the sector as a whole). Looking out to 2011E, when we expect auto markets to have normalised to a greater degree, our estimates put VW at only 1.3x at the current share price. Recognising some of the risks inherent in the merger and future dilution, we conservatively believe that the company should trade at 1.7x, from which we derive a share price of €80 for the prefs.

An average of both these valuation metrics leads us to set a €85 price target for the preference shares.

Inherent in our valuation is a 20% spread between the prefs and the ords, which is below the historical 35% discount. With the pref shares becoming the primary trading vehicle going forward, following likely DAX inclusion, as well as limited effective voting rights for the surviving public ord shares, we believe the discount should narrow.

Risks which May Impede the Achievement of the Price Target: Risks to price target

The main risks to our price target, in our view, are:

1) External risk – macroeconomic factors outside the control of the company, leading to an even weaker demand and pricing environment than we currently assume, could make our forecasts difficult to achieve.

2) Risks from financial transactions – VW plans to issue future equity, purchase assets from Porsche and Porsche family companies, and complete a merger of Porsche AG into VW AG. The pricing and terms for the equity issuance and future merger are not known at this point, and may be set in a way that prejudices owners of VW pref or ord shares.

3) Risks around pref/ord discount: the pref to ord discount has been volatile, dipping as low as 90% -- any return to 'abnormal’ discount levels would put our pref target at risk

Porsche Automobil Holding SE (PAH3 GY / PSHG_p.DE)

Valuation Methodology: We value the Porsche preference share based on an average of EV/sales and EV/EBITDA metrics at historical and peer average multiples:

1. EV/sales- Porsche prefs have historically traded at an eight-year average of 100% EV/sales, although rose to 200% as sales dipped in 2009. At current market price the shares are only trading at 27% 2010E EV/sales on our estimates. We believe given the fundraising and merger risks that Porsche should trade at 50% EV/Sales, closer to the peer historical average of 43%, and implying a value of €60/share.

2. EV/EBITDA - Historically Porsche has traded at an average of 4.6x EV to EBITDA during 2001-07 (before the extensive distortion of its options earnings) -- vs 3.4x for the sector as a whole). Looking out to 2011E, when we expect the merger to finalize, at the current market price the share is trading at only 1.3x. Recognizing some of the risks inherent in the merger and future dilution, we conservatively believe that the company should trade at 3.1x, from which we derive a price of €50/share.

An average of both these valuation metrics leads us to set a €55 price target.

Risks which May Impede the Achievement of the Price Target: The main risks to our price target are:

1) External risk – macroeconomic factors outside the control of the company, leading to a stronger demand and pricing environment than we currently assume, could mean the company exceeds our forecasts.

2) Risks from financial transactions – Porsche plans to issue future equity and complete a merger of Porsche AG into VW AG. The pricing and terms for the equity issuance and future merger are not known at this point, at may be set in a way that prejudices owners of Porsche pref shares



8 December 2009 177

ANALYST(S) CERTIFICATION(S)

We, Kristina Church and Brian A. Johnson, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directlyor indirectly related to the specific recommendations or views expressed in this research report.

IMPORTANT DISCLOSURES CONTINUED

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Primary Stocks (Ticker, Date, Price)

BMW (BMWG.DE, 04-Dec-2009, EUR 32.75), 1-Overweight/2-Neutral

Daimler AG (DAIGn.DE, 04-Dec-2009, EUR 35.91), 3-Underweight/2-Neutral

Fiat SpA (FIA.MI, 04-Dec-2009, EUR 10.56), 3-Underweight/2-Neutral

Peugeot SA (PEUP.PA, 04-Dec-2009, EUR 24.18), 2-Equal Weight/2-Neutral

Porsche Automobil Holding SE (PSHG_p.DE, 04-Dec-2009, EUR 47.51), 2-Equal Weight/2-Neutral

Renault SA (RENA.PA, 04-Dec-2009, EUR 35.59), 1-Overweight/2-Neutral

Volkswagen AG (VOWG.DE, 04-Dec-2009, EUR 80.39), 2-Equal Weight/2-Neutral

Volkswagen AG-PFD Preferred (VOWG_p.DE, 04-Dec-2009, EUR 63.50), 1-Overweight/2-Neutral

Guide to the Barclays Capital Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the “sector coverage universe”).

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors


8 December 2009 178

IMPORTANT DISCLOSURES CONTINUED

should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals/valuations are improving.

2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

3-Negative - sector coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "sector coverage universe":

European Autos & Auto Parts

BMW (BMWG.DE) Daimler AG (DAIGn.DE) Fiat SpA (FIA.MI)

Peugeot SA (PEUP.PA) Porsche Automobil Holding SE (PSHG_p.DE) Renault SA (RENA.PA)

Volkswagen AG (VOWG.DE) Volkswagen AG-PFD Preferred (VOWG_p.DE)

Distribution of Ratings:

Barclays Capital Inc. Equity Research has 1375 companies under coverage.

40% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 44% ofcompanies with this rating are investment banking clients of the Firm.

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In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed toinstitutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 2-2-2, Otemachi, Chiyoda-ku, Tokyo 100-0004, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firmregulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143.

Barclays Bank PLC Frankfurt Branch is distributing this material in Germany under the supervision of Bundesanstalt für Finanzdienstleistungsaufsicht(BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd.

IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should beconstrued to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from anindependent tax advisor.

© Copyright Barclays Bank PLC (2009). All rights reserved. No part of this publication may be reproduced in any manner without the prior writtenpermission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London,E14 5HP. Additional information regarding this publication will be furnished upon request.

BCS09-000348

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware thatthe firm may have a conflict of interest that could affect the objectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified asresearch analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 177.

EQUITY RESEARCH 8 December 2009

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European Autos & Parts 2009 Q4 Barclays