(FORTUNE Magazine) – AMERICAN MOTORS CORP. hardly had time to chill the champagne to toast its first profitable year since 1979 when upsetting news came from Renault, AMC's French partner and sugar daddy through its lean years. Chairman Bernard Hanon, 53, a prime mover behind Renault's half-billion-dollar investment in AMC, was fired in a shake-up triggered by huge losses. His replacement, a newcomer to the auto business, made his managerial reputation as a no-nonsense cost cutter. The cars AMC is banking on to nail down a solid share of the U.S. car market are largely French designed and French developed. An abrupt shift in strategy at the huge government-owned French automaker could leave AMC out in the cold. The outlook for AMC is chilly in any case. When the company reports its 1984 results, profits will be around $15 million on revenues of some $4 billion. Though that is a vast improvement over last year's loss on continuing operations of $258 million, it's mere pocket change compared with the stupendous profitability of General Motors, Ford, and Chrysler. And most of AMC's profit came from its popular four-wheel-drive Jeep specialty vehicles, not from its hard-won 2% share of the U.S. passenger car market. AMC's cars --the Alliance, based on the Renault 9 sold in Europe, and the hatchback Encore, based on the European Renault 11--are both subcompacts and have been marginally profitable at best. AIMED AT the lowest price range--the Alliance has a sticker price starting at $5,995--the cars were well received by the press when they were introduced. Sales also got off to a good start, but then hit a plateau. Despite offering such incentives as low-interest loans to buyers, AMC dealers recently were saddled with larger inventories--about double the normal 65 days' worth--than other U.S. car dealers. And there's more trouble ahead. A growing number of auto industry experts, prominent among them Maryann Keller, a director at the New York investment firm Vilas-Fischer Associates, are warning of new competition in the market for small cars. It will come from such sources as the GM-Toyota joint venture in California, from Nissan's new car assembly line in Tennessee, and from an easing, if not abolition, of the quotas on Japanese imports. ''Competition is going to heat up in the next two months,'' Keller says. ''It will intensify in the next year or so, and the outlook for profit margins will get worse in subsequent years.'' An all-out price war could force AMC back to Renault for more cash. But Renault, which is expected to report a $1-billion loss on revenues of $11 billion for 1984, might not come up with much. The new man at Renault, Georges Besse, 57, who moved over from the top job at Pechiney, the state-owned aluminum maker, isn't talking yet. Aides have passed the word that Besse needs time to look around his new empire before deciding what to do about either AMC or Renault. The hopeful word from AMC's Southfield, Michigan, headquarters is that the change in command will have ''no effect on AMC that we can determine.'' (And you can bet AMC is trying hard to determine.) Renault currently owns 46.1% of AMC's common stock, and enough warrants and convertible securities to bring the total to some 55%. Felix Rohatyn, the New York investment banker who is a Renault-nominated member of AMC's board and also a director of Pechiney, argues that Renault's AMC connection gives it the best shot of any European automaker to be a major player in the American market in the next 15 years. ''Obviously, Mr. Besse will decide if there's to be any change in Renault's U.S. policy,'' says Rohatyn, ''but I would be surprised if he made any.'' Surely Besse is going to have to change something at Renault. President Francois Mitterrand's Socialists aren't eager to go into next year's legislative elections dogged by an ailing Renault. Since many other nationalized industries have already turned around, the company is a highly visible blot. Not only is Renault hemorrhaging cash, it's no longer No. 1 in Europe, the position it held from 1980 to 1983. The market research firm DRI Europe estimates that Renault's European market share fell from 12.6% to 10.9% - last year, bumping the company to sixth place--behind Ford, Fiat, Volkswagen, Peugeot, and General Motors. Hanon was caught in a classic squeeze. He spent heavily to automate Renault's production lines, then ran into opposition from Renault's often militant unions when he tried to cut the work force. The unions zapped the company with strikes at key plants last September. The strikes were over a variety of issues, but the message behind them was that the unions wouldn't stand for layoffs. At the same time, government price controls cut profit margins to nothing on cars sold in France, Renault's most important market. Competition, especially from Fiat's Uno and Peugeot's 205, ate into Renault's European market share and the company had to spread its bloated overhead across a lower unit volume. Renault started losing money in 1981. Besse will have more leeway in cutting the work force than Hanon did, because of a shift in government policy. He's bound to make use of it, but once he does, any further investment by Renault in AMC would doubtless stir controversy since the unions could view that as exporting French jobs. When Besse came to Pechiney in 1982 from the state-owned nuclear fuel industry, the recently nationalized aluminum producer was on its way to losing $455 million for the year on revenues of $4.4 billion. Besse unloaded an unprofitable chemical operation, consolidated the company's aluminum-smelting capacity, cut the work force, and invested in lower-cost capacity in Australia and Canada. For 1984 Pechiney is expected to post profits of some $50 million. When Besse turns to AMC, the question will be what has Renault got for its money? One answer is that it got the faithful execution of a strategy designed for the world car market as it looked in 1979. The trouble is that strategy hasn't aged gracefully. Back in 1979, when the two companies got together, Renault was nicely profitable and well on its way to market leadership in Europe selling practical, economical cars. The popular notion among auto executives at the time was that the worldwide business was destined to shake down to a handful of high-volume producers. Determined that Renault should be a survivor, Hanon began looking for ways to build volume and economies of scale. Renault was barely in the U.S. market, selling a trickle of cars through a patchy dealer network. With the dollar then relatively weak against the franc, manufacturing in the U.S. seemed the best way to grow. Fuel prices were rising and the major U.S. carmakers had yet to bring out large numbers of small, fuel-efficient cars. So Renault's thrifty, front-wheel-drive models looked like sure winners. In AMC, Renault found a partner with a ready-made manufacturing base and dealer network. AMC had lurched through the 1970s with three product lines: a generally profitable line of government vehicles; Jeeps, which sold well and at high margins when consumers weren't overly concerned about fuel efficiency; and passenger cars, which appealed mostly to price-sensitive buyers. AMC had considered and rejected the idea of abandoning passenger cars to concentrate on Jeeps. Renault was a welcome source of new models to manufacture and import. At the outset AMC promised to be a self-sufficient partner. It was coming off a near record year--1979 profits totaled $83.9 million on revenues of $3.1 billion. Renault was to help finance the conversion of AMC's main auto plant in Kenosha, Wisconsin, to produce Renault models, while AMC seemed able to take care of its other big project, development of a new line of fuel- efficient Jeeps. But in 1980 both car and Jeep sales slipped, pushing AMC into a losing streak that ended only in the last quarter of 1983. To finance capital expenditures--$1 billion worth in the past five years--AMC loaded up on debt, issued equity, and sold its headquarters building and government- vehicles business. As AMC's condition worsened, Renault anted up in stages to its current investment of $545 million. The Renault-designed cars came out just in time to encounter a sag in the small-car market. As fuel prices fell, consumers began to drift away from small cars, leaving behind only those buyers who couldn't afford--or didn't care about--anything fancier. The Alliance and Encore had to scramble against low-priced Chevrolet Chevettes, Ford Escorts, and Chrysler Omnis and Horizons, as well as a slew of Japanese imports. HARDLY ANYBODY who follows the auto industry believes that AMC makes money on small cars. And hardly anybody can imagine what the company would do without its profitable Jeep line. In the fall of 1983 AMC launched its new, smaller versions of the four-wheel-drive Cherokee and Wagoneer. AMC's Jeeps and their various derivatives fit nicely into the latest market philosophy among auto executives--find and exploit special niches. But the company also wants to follow the crowd into the market for larger, fancier cars that command higher profit margins. The competition may be even hotter than in the small-car market, but with sales of the Alliance and Encore slipping, AMC figures it has no choice. The company is building a new plant in Ontario to make an intermediate-size car similar to the Renault 25, which in Europe is Renault's top-of-the-line executive sedan. AMC plans to start producing at an annual rate of 150,000 sedans and coupes in 1987. To give its dealers something to sell until then, the company apparently is resigned to making small cars as a necessary evil until better days come. Says Joseph Cappy, AMC's group vice president for sales and marketing: ''You need to have a volume base and brand awareness to sell a product with a high price tag. You can't just say, 'Two years from now we'll have the product, and then we'll get the dealer network in place.' '' To fill in its product line, AMC plans to import some models from Renault. AMC's dealers already carry the imported Fuego sports coupe and the Renault 18i, called the Sportwagon in the U.S. But neither of these French creations has caused much commotion among American consumers. The company is hoping for greater success with a high-performance sports car called the Alpine, a minivan, and a sedan just slightly larger and plusher than the Alliance. To broaden Jeep's coverage of the market, AMC will introduce a two-wheel-drive version of the Cherokee this spring, and a compact Jeep pickup truck in the fall. AMC estimates that these and future new products will require some $1.8 billion in capital expenditures between now and 1989. The company insists that it won't be hitting up Renault for additional cash in the next few years, that it will cover its needs with cash flow and bank financing. Although AMC's balance sheet has improved recently, long-term debt still is a hefty 60% of total capital. That means bankers will be especially interested in seeing a vigorous flow of cash. Certainly Jeep promises to be a reliable source. But if stiff competition turns the Alliance and Encore into heavy cash drains, AMC could lose money again--conceivably this year--and once more face a decision on whether to pull out of passenger-car manufacturing. The next time around, the boss at Renault may not be so eager, or so able, to keep its partner in the business. BOX: INVESTOR'S SNAPSHOT AMERICAN MOTORS SALES (LATEST FOUR QUARTERS) $4.3 BILLION CHANGE FROM YEAR EARLIER UP 46% NET PROFIT $19.7 MILLION CHANGE LOSS YEAR EARLIER RETURN ON COMMON STOCKHOLDERS' EQUITY 3% FIVE-YEAR AVERAGE -76% RECENT SHARE PRICE $3.75 PRICE/EARNINGS MULTIPLE 42 TOTAL RETURN TO INVESTORS (12 MONTHS TO 2/1) -41% PRINCIPAL MARKET NYSE Explanatory notes: page 178