Chrysler's Upswing Continues Despite Europe Woes

Detroit's No. 3 automaker had a pretty nice quarter: Chrysler reported a $436 million second-quarter profit on Monday, and said that it is on track to reach $1.5 billion in profits for the full year.

Scrappy Chrysler has long been the runt of the Detroit litter, often barely scraping by even while its local rivals thrived. But since Fiat (OTC: FIATY) took control as part of Chrysler's post-bankruptcy bailout in 2009 and set out to remake the company on the fly, Chrysler has been on a big -- and surprising -- upswing.

And that's a good thing, because right now, Fiat is having some big troubles of its own.

The two pillars of Chrysler's strength
Chrysler's profit was down slightly from the $473 million it booked in the first quarter, but it was still a strong showing, far ahead of the $370 million loss it booked in the year-ago period -- a loss driven by a whopper of a one-time item: Chrysler's repayment of its bailout debts to the U.S. and Canadian governments.

The key source of Chrysler's strength has been a simple and obvious one: Its lineup of cars and trucks, artfully revamped on the fly with help from Fiat, have caught on with buyers. Chrysler's U.S. sales were up 30.3% in the first half of 2012 -- the largest gain among major automakers, even ahead of rebounding Toyota (NYS: TM) and Honda (NYS: HMC) .

But Chrysler's strong products are just part of the story. Over the last couple of years, Chrysler has developed a special relationship with a unit of Spanish bank Santander (NYS: SAN) that specializes in subprime lending. The upshot: Recession-battered buyers may be finding a friendlier welcome in the financing department of Chrysler's dealers than they have found elsewhere. That has been a big part of Chrysler's sales growth, some analysts say. And so far it has worked out well -- default rates remain modest.

For parent Fiat, Chrysler's success in its home market has been a boon -- because Fiat itself is struggling mightily in its home market.

Meanwhile, Fiat's house is under siege
CEO Sergio Marchionne likes to refer to the Fiat-Chrysler mashup as one automaker in two "houses," and right now the house of Fiat is under pressure. Like most automakers doing business in recession-hammered Europe, Turin-based Fiat is losing ground in a declining auto market. Much of the region is suffering, but Spain and Italy in particular -- Fiat's home turf -- have been hit especially hard by economic woes.

Automakers, including Fiat, have responded with heavy discounts to keep sales up, and a price war has erupted in some areas. That price war has clobbered Fiat's margins and led to angry words from Marchionne, amid suggestions that archrival Volkswagen (OTC: VLKAY) has been subsidizing its European sales to grab market share while rivals struggle.

The results have hit Fiat's earnings -- Fiat lost 184 million euros (about $226 million) in Europe in the second quarter. That's not nearly as bad as the losses that Ford (NYS: F) or General Motors (NYS: GM) have posted in the region lately -- but Fiat's restructuring program is already well under way, and the continuing red ink suggests that it may not be going far enough.

Marchionne said recently that he will reduce Fiat's spending in Europe by 500 million euros this year, a savings that may mean postponing or cancelling new-product launches amid continuing declines in the overall auto market. Will that be enough?

A rough road for Fiat
The problem in Europe is industrywide, and unlikely to be cured by an economic upswing. In a nutshell, Europe has too many car factories. Some estimates say that Europe's auto-manufacturing capacity could be as much as 2 million vehicles above market demand, a recipe for tight margins in the best of times.

And these aren't the best of times. Marchionne has called for a cooperative approach to reducing Europe's production capacity, calls that have been met with derision by other industry leaders. Meanwhile, Fiat's red ink at home is likely to continue for a while, as better-funded Volkswagen keeps up the pressure. Marchionne had better hope that Chrysler's profitable success in the U.S. continues.

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