Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

They said this day would never arrive. PSA Peugeot Citroen's 5 percent recurring operating margin in 2015 is almost as improbable as the French praising British cuisine.

The carmaker lost more than 8 billion euros ($8.8 billion) between 2012 and 2014, according to Bloomberg data, was almost given up for dead and had to be bailed out by France's government. Yet it's delivered a level of profitability that's dazzling by the modest standards of Europe's mass-market carmakers.  

Carlos Tavares, an ambitious former Renault executive, took over at PSA less than two years ago and set the bar low. PSA was targeting a 2 percent operating margin by 2018 (roughly in line with its historical average) and a 5 percent margin sometime before 2023. Tavares has delivered, and then some.

Magical Margins
Cost cuts have helped PSA generate an unusual level of profit for a European mass-market carmaker
Source: company reports
Note: VW brand margin is for 2014 , rest is for 2015

A plant closure, pay freeze and thousands of job cuts -- all started under Tavares's predecessor -- have boosted productivity. Savings in production and procurement contributed 40 percent of operating profit gains last year. Simply put, PSA has cut fixed costs and is spending less on purchasing, thereby lowering its break-even point. The company has also found savings in selling and administrative expenses.

PSA Performs
Fixed cost and procurement savings have helped transform the French carmaker. The strong pound also helped.
Source: Company presentation
Nb. Chart excludes some of contributory factors to automotive profit, hence total is greater.

It's unfashionable to attribute a carmaker's transformation to the fact that it sells cars customers want to buy. But PSA is doing that too. Sales of the quirky Citroen C4 Cactus (which looks like it has chocolate bars stuck to its sides) almost doubled last year. Good design helps support pricing.

Is the turnaround sustainable? Tavares may yet regret over-achieving so quickly. Investors have a quirky preference for slow but consistent profit improvement (as opposed to a sudden profit jump followed by a flattening). PSA had quite a bit of help last year from the strong pound, which boosts the value of U.K. sales. With Brexit fears weighing on the currency that doesn't look like it will be maintained.

In addition, emission compliance costs will probably rise after the Volkswagen scandal. PSA's Asia exposure -- China and Southeast Asia are about a quarter of sales -- could become a bigger drag. And the European market's recovery isn't baked in either: PSA expects it to increase 2 percent in 2016 and China by 5 percent.

Finally, Tavares seems determined to turn the historic DS brand, beloved by French presidents, into a premium carmaker. That helps boost profit per vehicle but will need lots of investment if it hopes to keep pace with the German brands. Sales of DS cars fell 13 percent last year but Tavares says his priority is margin, not volume.

Tracking Tavares
The new boss has led a revival at PSA Peugeot Citroen. Can it last?
Bloomberg data

Amid broader market turmoil, PSA shares have given up much of last year's gains but they still price in a fair bit of optimism, perhaps reflecting hopes that it will be involved in industry consolidation.

At 8.1 times forward earnings, it looks expensive compared to compatriot Renault, on 6.5 times. PSA margins are superior but it doesn't plan to start paying a dividend until the end of the new financial year. Renault has a 3 percent yield. Still, credit where it's due, Tavares has dragged an impressive performance out of a former basket case. Investors have high expectations for the next act.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net