Automakers face stiff headwinds in big emerging markets

Brazil, Russia, India and China disappoint as manufacturers face investment demands of EVs © Bloomberg

Less than a third of China’s 31,000 auto dealers were profitable in the first half of 2019, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Auto markets in the Bric countries are facing two major challenges. The first relates to the downturn already under way in the two largest markets, China and India, where 2019 sales seem likely to be at least 10 per cent below the previous year’s levels.

The second is the need for manufacturers and parts suppliers to spend billions of dollars on the transition to electric vehicles in order to meet Chinese government production targets in 2021-23.

It therefore seems probable that winners and losers will emerge over the next 18 months, as companies along the value chain find themselves short of cash to fund the new investments required.

China’s downturn is particularly important as sales in Brazil, Russia and India have already fallen by 20 per cent since peaking in 2012, as the chart below shows (January-November basis). Chinese sales have been in a downturn for more than a year, and the impact is broadening along the supply chain.


As Automotive News reported: “We knew China had been in a prolonged auto sales slump, and we knew the market was under pressure from tougher municipal and provincial emissions standards. Now, we’re seeing how these factors are devastating dealerships, to the tune of half of them being sold and several hundred being driven out of business.”

Less than a third of China’s 31,000 dealerships were profitable in the first half of 2019. The downturn is particularly bad news for western manufacturers, whose global profits have depended on China volumes.

US brands are worst hit, with January-November sales down 23 per cent due to frictions caused by the US-China trade war. General Motors reported third-quarter China sales down 17.5 per cent, continuing their slide since the second quarter of 2018, with sales also hit by strong competition in the key mid-priced sport utility vehicle segment. Ford saw its third-quarter sales fall 30 per cent — accelerating the downturn that began at the end of 2017.

French brands are having a difficult time, with volume down 54 per cent in January-November. Seventy per cent of Peugeot, Citroën and Renault’s dealerships were lossmaking in the first half of last year.

Korean brands were down 15 per cent, and even German brands had no growth over the previous year.

The problem is magnified by the fact that China’s market has seen rapid growth since 2008. Many companies and dealerships therefore assumed that the sales ramp-up from 550,000 vehicles a month in 2008 to 2m a month by 2016 was somehow “normal”. They have no concept of a slowdown, or how to survive it.

The downturn is likely to intensify as the government continues to squeeze the shadow banking sector and hence the property market. As the chart below shows, shadow lending remains well down on its earlier peaks, averaging just $67bn a month in the 10 months to October. This means, as we noted here a year ago, that “buyers can no longer count on windfall gains from property speculation to finance their purchase”.


As Reuters notes, the scale of the previous stimulus-driven growth also means that today, “much of the urban middle class has already purchased a vehicle. Household ownership rates were nearing 50 per cent in the provincial-level cities of Beijing and Tianjin and the wealthy province of Zhejiang by the end of 2017… Pushing ownership further down the income scale in urban areas as well as out into the poorer countryside is harder without generous tax incentives, plentiful credit and fast growth in incomes.”

Sales in the other Bric markets are also slowing. India’s sales were down 13 per cent at the end of November, while in Russia the industry is now forecasting a 2 per cent decline. Even in Brazil, industry trade group Anfavea has reduced its growth forecast to 8 per cent, due to the slowing Latin American economy.

The downturn creates a major dilemma for the industry, as it coincides with the need to commit to major new investments in EV manufacture.

China is proposing to set a 14 per cent target for EV production in 2021, rising to 16 per cent in 2022 and 18 per cent in 2023. Similarly, the industry ministry has called for EVs to be 25 per cent of total new car sales by 2025, and announced that “regions with ripe conditions have our support if they establish trial projects to establish no-go zones for gasoline-powered vehicles and replace them with new energy vehicles in the urban public transport system”.

Companies therefore have to move forward with EV investments, even though their profits are under pressure from the sales downturn.

Volkswagen, for example, is planning to open two Chinese EV factories this year with total capacity of 600,000 cars, and aims to produce 11.6m EVs in China by 2028. Tesla is opening capacity for 250,000 cars and plans to double production in the future.

With other manufacturers following suit, some in the industry expect EV prices to fall below those for internal combustion engines within the next two years, which would further accelerate the transition.

The industry is therefore faced with a stark choice. The need to commit to EV manufacture means there is no “business as usual” strategy for either manufacturers or parts suppliers. Those who decide to conserve their cash risk finding themselves without the relevant products and services in the world’s largest auto market.

Paul Hodges publishes The pH Report.

Auto markets set for major disruption as Electric Vehicle sales reach tipping point

Major disruption is starting to occur in the world’s largest manufacturing industry.  Hundreds of thousands of jobs will likely be lost in the next few years in auto manufacturing and its supply chains, as consumers move over to Electric Vehicles (EVs).

As the chart from Idaho National Laboratory confirms, EVs have relatively few parts – less than 20 in the drive-train, for example – versus 2000 for internal combustion engines (ICEs).  There is much less to go wrong, so many servicing jobs will also disappear.

The auto industry itself was the product of such a paradigm shift in the early 19th century, when the horse-drawn industry mostly went out of business.  Now it is seeing its own shift, as battery costs start to reach the critical $100/kWh levels at which EVs become cheaper to own and operate than ICEs.

Unfortunately, this paradigm shift is coming at a time when global sales and profits are already falling. As the chart shows, sales were down 5.4% in January-August in the Top 7 markets versus 2018. And in the Top 6 markets, outside China, they were only 4% higher than in 2007, highlighting the industry’s current over-dependence on China:

  • India is suffering the most, with sales down 15% this year
  • But China’s woes matter most as it is the largest global market; its sales were down 13%
  • Europe was down 3% YTD, but on a weakening trend with August down 8%
    • All the major countries were negative in August, with Spain down 31%
  • Russia was down 2%, despite the economic boost provided by today’s relatively high oil prices
  • The USA and Japan were marginally positive, up 0.4% and 0.6% respectively
  • Only Brazil was showing strong growth at 9%, but was still down 28% versus its 2011 peak

EV sales, like those of used cars, are heading in the opposite direction. China currently accounts for 2/3rds of global EV sales and sold nearly 1.3m EVs in 2018 (up 62% versus 2017). They may well take 50% of the Chinese market by 2025, as the government is now focused on accelerating the transition via the rollout of a national charging network.

Interestingly, it seems that Europe is likely to emerge as the main challenger to China in the global EV market. The US has Tesla, which continues to attract vast investment from Wall Street, but it is only expected to produce a maximum of 400k cars this year. Europe, however, is ramping up EV output very fast as the Financial Times chart confirms:

  • The left-hand scale shows EV prices v range (km) for EVs being released in Europe
  • The right-hand scale shows the dramatic acceleration in EV launches in 2019-21

One key incentive is the manufacturers’ ability to use EV sales to gain “super-credits” in respect of the new mandatory CO2 emission levels. These are now very valuable given the loss of emission credits due to the collapse of diesel sales.

2020 is the key year for these “super-credits” as they are the equivalent of 2 cars, before scaling down to 1.67 cars in 2021 and 1.33 cars in 2022.  Every gram of CO2 emissions above 95g/km will incur a fine of €95/car sold. And as Ford’s CEO has noted:

“There’s only going to be a few winners who create the platforms for the future.”

VW NOW HAVE BATTERY COSTS AT BELOW $100/kWh
VW is likely to be one of the Winners in the new market.  It is planning an €80bn spend to produce 70 EV models based on standardised motors, batteries and other components.  This will enable it to reduce costs and accelerate the roll-out:

  • Its new new flagship ID.3 model will go on sale next year at a typical mid-market price of €30k ($34k)
  • Having disrupted that market segment, it will then expand into cheaper models
  • And it expects a quarter of its European sales to run on battery power by 2025.

The key issue, of course, is battery cost. $100/kWh is the tipping point at which it becomes cheaper to run an EV than an ICE. And now VW are claiming to have achieved this for the ID.3 model.

Once this becomes clearly established, EV sales will enter a virtuous circle, as buyers realise that the resale value of ICE models is likely to fall quite sharply.  Diesel cars have already seen this process in action as a result of the “dieselgate” scandal – they were just 31% of European sales in Q2, versus 52% in 2015 .

One other factor is likely to prove critical. The media hype around Tesla has led to an assumption that individuals will lead the transition to battery power.  But in reality, fleet owners are far more likely to transition first:

  • They have a laser-like focus on costs and often operate on relatively regular routes in city centres
  • They don’t have the “range anxiety” of private motorists and can easily recharge overnight in depots

The problem for auto companies, their investors and their supply chain, is that the disruption caused by the paradigm shift will create a few Winners – and many Losers – as Ford warned. 

Those who delay making the investments required are almost certain to become Losers.  The reason is simple – if today’s decline in auto sales accelerates, as seems likely,  the investment needed for EVs will simply become unaffordable for many companies.

 

 

Auto sales and the oil price: the Great Unwinding continues

Serious questions need to be asked about the likely level of future demand growth for oil and auto sales in Emerging Markets (EMs), as I describe in my latest post for the Financial Times, published on the BeyondBrics blog 
Brent Jul16
Oil market volatility has reached near-record levels in H1 this year, as the first chart shows. It has averaged nearly 10% a week, and over the past quarter-century its three-month average has only been higher during the Gulf War and the subprime crash. Yet there have been no major supply disruptions or financial shocks to justify such a dramatic increase. Instead, July’s report from the International Energy Agency reminds us that:

“OECD commercial inventories built by 13.5 mb in May to end the month at a record 3 074 mb. Preliminary information for June suggests that OECD stocks added a further 0.9 mb while floating storage has continued to build, reaching its highest level since 2009.”

The problem is two-fold:

  • Financial markets are now reaching the hard part of the Great Unwinding of policymaker stimulus, which began nearly two years ago as we have described in beyondbrics. Their key role of price discovery has been subverted by the tidal waves of central bank liquidity, and today’s elevated levels of volatility suggest it will be a difficult journey back, as markets return to valuations that are instead based on the fundamentals of supply and demand
  • Life has not stood still over the past few years, and so there will also be plenty of surprises along the way as players are forced to recognise that many of their core assumptions are either untrue or out of date. The excitement of the 2009–2014 stimulus period, for example, seems to have led many investors to ignore the 2012 warning from then Saudi oil minister Ali al-Naimi that “Oil demand will peak way ahead of supply”. Today, they are being forced to play catch-up, as they digest the implications of Saudi Arabia’s new National Transformation Plan. Yet its core objective that “Within 20 years, we will be an economy that doesn’t depend mainly on oil”, is clearly linked to Naimi’s earlier insight.

EIA Jul16

New data from the US Energy Information Agency (EIA) confirms Saudi Arabia’s need for a change of direction, as the chart shows. The EIA’s reference case scenario out to 2040 suggests that US energy consumption will increasingly be led by natural gas and renewables, and notes that

“Petroleum consumption remains similar to current levels through 2040, as fuel economy improvements and other changes in the transportation sector offset growth in population and travel.

Nor are these trends confined to the US. As Nick Butler has argued recently in the FT, conventional forecasts of ever-rising energy demand driven by rising populations and rising prosperity in the EMs appear far too simplistic. Instead, as he notes: “Demand has stagnated and in some areas is falling.”

Developments in the transportation sector (the largest source of petroleum demand), confirm that a paradigm shift is now underway along the whole value chain. As Dan Amman, president of GM, highlighted in the FT last year, when discussing the value proposition for city dwellers of buying a new car:

“It’s the last thing you should do because you buy this asset, it depreciates fairly rapidly, you use it 3 per cent of the time, and you pay a vast amount of money to park it for the other 97 per cent of the time.”

All autos Jul16

China’s slowdown confirms the depth of the challenge to conventional thinking about future auto and oil demand. Many still assume that EMs will account for two thirds of global auto sales by 2020, and underpin future oil demand growth. But the China-induced collapse of commodity export revenues in formerly high-flying economies such as Brazil and Russia means that this rosy scenario is also in need of major revision.

As noted last November, Brazil was temporarily the world’s fourth largest auto market in 2013, whilst Russia was forecast to reach fifth position by 2020. But as the chart of H1 sales in the BRIC countries shows, volumes in both countries have almost halved since then. China’s own sales growth is also slowing, as the government’s need to combat pollution has led it to focus on implementing policies aimed at boosting the role of car sharing and public transport – while its focus on electric vehicles is a further downside for future oil demand.

As we move into H2, it therefore appears that the fundamental assumptions behind the $3tn of energy market debt – $100/bbl oil and double-digit economic growth in China – are looking increasingly implausible. And given oil’s pivotal role in the global economy, today’s near-record levels of oil market volatility may also be trying to warn us that wider problems lie ahead for financial and energy markets.

US auto sales head towards price war as subprime loans rise

US autos Mar16

The warnings keep coming about the underlying health of the US auto market.  But, as with the subprime housing crisis, nobody wants to listen:

  • Last October, the US Comptroller of the Currency warned that some activity “in auto loans reminds me of what happened in mortgage-backed securities in the run-up to the crisis
  • Yet auto lending is now more than 10% of total retail lending, and the banks are still busy repackaging them for sale as securities to investors desperate for yield

There are 2 parts to the story, as the charts above show, both from the Wall Street Journal (WSJ):

  • Auto leasing is now at record levels at 1/3rd of total car loans, compared to pre-crisis levels of one in five
  • Manufacturers subsidise these deals to make them attractive  – currently by an average of $6432
  • These lease incentives have been rising sharply, and are up 8% versus 2015 and 29% versus 2009
  • Auto loans are also now at record levels, close to $1tn, with 20% going to subprime borrowers
  • Issuance of bonds backed by subprime loans is up 25% from 2014, and these are already going sour
  • 12% of loans in bonds only issued in November were already overdue by February

Of course, everyone insists that the Comptroller is wrong to be worried, just as they said the housing market was in great shape – until it collapsed.  But warning signs are everywhere, if one wants to look. Delinquency rates on subprime loans packaged over the past 5 years are already over 5% – and that is with an improving jobs market.

The problem is that loans are being made to people with very low credit scores, or even no credit scores.  And they are being asked to pay interest rates of around 20%.  This is clearly unsustainable, and highlights how the auto industry is gradually running out of potential new customers – just as happened with housing.

At the same time, manufacturer inventories are rising, up to around 90 days for Ford and Fiat Chrysler, whilst overall incentives have risen to 10.6% of revenue.  Ford’s car inventory is 38% above its normal level at this time of year, despite it having boosted lower-margin rental car deliveries (adding 7% to its total volume).

As Credit Suisse note, auto makers will soon have to cut production, as their current sales strategies are running out of road.  They expect a 6% cutback from Q2, meaning that 2016 production would be flat versus 2015.  But this may well prove too optimistic.

The reason is that nearly 9 out of 10 new cars are currently financed:

  • Loans are typically 6 years, so even buyers from 2012 won’t return to the showroom till 2018
  • Lease terms are typically 3 years, meaning 2016 will see large numbers low mileage cars in the used car market

Used cars are therefore going to have a very attractive value proposition for the ordinary buyer, as their average mileage is currently back to 2002 levels:

  • 3.1m cars come off lease this year, a 20% increase versus 2015, followed by 3.6m in 2017 and 4m in 2018
  • These used car sales will cannibalise new car sales, pushing down prices and volumes
  • Price wars are therefore almost inevitable over the next 18 months, and lenders will start to lose serious money

The industry has been here twice before, as the WSJ notes – and both times the story ended very badly, with lending losses running into the billions of dollars:

“The auto industry expanded the use of leasing in the mid-1990s, helping to fuel retail sales of new vehicles. Eventually, a glut of off-lease cars sent resale values down and auto lenders who had bet residuals would remain high ended up racking up billions of dollars in losses, having to sell the cars for much less than they anticipated.

“Many major banks exited leasing the early 2000s, but the practice resumed later in the decade. Lenders saw another leasing crash late last decade when resale values plummeted amid a steep rise in gasoline prices and low demand.”

Of course, all those making short-term bonuses from selling the loans and leases, or repackaging them for sale to investors, naturally claim that everything is fine.  But the rest of us know what to expect.

Past experience is normally a good guide to the future outlook.

GM says owning a car in a city “is the last thing you should do”

EU autos Jul15Something strange is happening in the European auto market, as the above chart from the industry association shows:

  • Normally there are seasonal patterns, with March seeing the highest sales of the year
  • But the trend of increase or decline is normally fairly stable in either direction
  • This year, however, both March and now June have shown bumper percentage increases
  • March was up 10.6%, well above the rest of Q1: June was up 14.6%, again well above the rest of Q2

It seems unlikely that seasonal patterns have suddenly changed quite so much, especially as March has always been a strong month.

Instead, it seems more likely that dealers are self-registering new cars in order to meet quarterly sales targets from the manufacturers.  Thus the Financial Times reports that in reality UK sales are actually flat or falling – even though 7% more cars were registered as sold in H1 2015 versus 2014.  It note:

  • More than a quarter of registrations in June came on the last day of the month
  • “As many as half the registrations were being recorded in the final four days of the month as dealers push to meet targets
  • “(These are) so-called self-registrations, where dealers sell the cars to themselves to meet incentive targets from manufacturers. The cars are typically held for 90 days and then sold on as used vehicles.”

Estimates for UK self-registration suggest it now accounts for at least 11% of total UK sales, and higher percentages in other key markets such as Germany.  And this is despite average discounts in Germany now reaching 20%.

Leading manufacturers, of course, know that this is simply putting a sticking-plaster on the problem.  Ford, GM and BMW are all now pushing hard into the car-sharing market, even though they know this will reduce their overall sales:

  • Opel (part of GM) will offer “car sharing for everyone” via a dedicated Opel app on its CarUnity programme
  • From next year, BMW will allow Mini buyers to rent their car via its DriveNow network in London and in the US
  • Ford are allowing 12k London customers to rent their cars via peer-to-peer platform easyCar Club

As GM’s president said last month about owning a car in a city:

“It’s the last thing you should do because you buy this asset, it depreciates fairly rapidly, you use it 3 per cent of the time, and you pay a vast amount of money to park it for the other 97 per cent of the time”.

Auto manufacturers, unlike car dealers, have alternatives when it comes to confronting the challenge of car-sharing.  Smart ones will realise that increasing numbers of people are no longer interested in owning cars.  And so instead, they will focus on developing new income streams based on the megatrend of mobility.

Average US auto loan term hits record 68 months in May

US housing Jun15bMay was “another fantastic month for US auto sales”.  Or, it took the industry “one month closer to an inevitable downturn”.  All depends on which analyst you talk to:

  • Ward’s Autos called May’s sales the best since July 2005
  • LMC Automotive suggested growth rates were slowing, and could possibly even contract next year

It also depends on how many questions you ask.

The headline numbers are clearly good.  And they are not being achieved by major discounting, which was the position last year.  Then, average incentives had hit $2633 in February, and headed higher into the peak spring selling season.

But look a little deeper, and problems quickly emerge.   Prices in the used car market have begun to fall, with those for some “near-new” compact vehicles down 2.8%, and midsize values also weakening.  The reason is better availability, as buyers trade-in used cars for new leases.

The US Federal Reserve’s cheap credit policy has meant that 4 out of 5 auto sales are now bought with credit or leased.  Effectively, therefore, it is helping to grow the “sharing economy”, where drivers no longer feel the need to actually own the vehicle they drive.

This has good and bad results.  In the short-term, it means automakers can increase prices and margins, and still make sales as the cost is spread over a longer period.  But in the medium-term, it means they must expect to see lower sales in future years.  The reason is simply that lease terms have been rising to unheard-of levels.

The average US auto loan is now at 69.7 months, which means it will be 2021 before the buyer comes to the end of the loan period.  And as the chart shows, these changes in the market are challenging the dominance of the “Big 4′ US manufacturers:

    • Their combined share of the total market is now just 60%, well down from the 73% seen in Q2 2005
    • GM’s share is down at 18% versus 32% then (blue); Ford has slipped to 15% from 18% (green)
    • Toyota has recovered to 15% after its recalls (purple); FiatChrysler has slipped to 12% from 15% (red)

Volkswagen highlights the pressure they are under.  With an ageing fleet line-up, it is now forced to offer its Jetta model on a lease costing just $39/month in San Jose California, or between $89 – $99/month more generally.  You could end up paying more per month for some mobile phone packages.

And, of course, there is always car-sharing itself.  Ford have now followed BMW and Mercedes in entering the market with its new Go!Drive brand.  And each shared car takes 17 privately owned vehicles off the road, according to industry estimates.

Of course, many people will still want to drive their pick-up trucks and SUVs.  But there are clearly an increasing number of people who are looking for new ways of meeting their need for mobility.  As a result, it seems likely that the US auto market will look quite different in 5 and 10 years time.