The automotive industry has come a long way since 1908, when Ford’s [F] Model T revolutionised the sector by making cars affordable for the majority of Americans, and changed the course of the 20th century in the process.
But fast forward to today, and the industry is struggling. Trade headwinds, new legislation, fuel prices, material costs and weakening consumer demand are squeezing the sector’s already tight margins. While battery-powered cars are seen as a high-growth play in the long term as an electric onslaught from auto incumbents begins, petrol remains the biggest fraction of sales.
Since the start of 2019, both Ford and Jaguar Land Rover have announced major restructuring plans that are expected to lead to thousands of job losses. Ford’s stock declined 33% in 2018.
Depreciation of Ford shares in 2018
Back in June 2018 Daimler [DDAIF], the German manufacturer of Mercedes cars, revised down targets, blaming trade tensions between China and the US. Shortly afterwards, BMW issued a warning that earnings, margins and profits would suffer due to rising material costs. The news hit shares at the German carmaker and ricocheted around the sector, suggesting the industry could be facing a bumpy road in the year ahead.
CHALLENGES AND OPPORTUNITIES
Given the commercial pressures on the industry, Moody’s predicts light vehicle sales growth to slow in 2019. “Financially strong companies will be best positioned to manage the added drain on their resources,” it said in a report. Increased spending will likely put further pressure on the sector’s already low margins.
In China – which, as the world’s biggest car market, is often heralded as the sector’s saving grace – sales fell 13% in December 2018. The Chinese car market saw its first annual contraction since the 1990s, with annual sales at 28.1m, 2.8% down on the 2017 figures.
Despite poor vehicle sales in the second half of 2018, China is a still the crucial market for car manufacturers. It’s no longer just seen as the brawn, but increasingly as the brain of the sector. In a survey of top automotive executives, KPMG found that many felt China was outstripping mature markets, with “an increasing number ranking China among the first-mover countries to launch new mobility services and execute new data-driven business models”. On the flip side, 74% of executives believe that production in Western Europe will be less than 5% by 2030.
It will remain a strong driver of growth. A subsidence in the US-China trade war would provide a boost for both countries’ manufacturers while in an effort to boost sales, China is considering cutting its vehicle sales tax by 50%.
Japan’s Toyota remains a bright spot for investors as it had strong global sales in its Q2 earnings for the 2019 fiscal year, reaching a record high of $129bn, representing a 3% year-on-year rise. When asked about the company’s outlook in the Chinese market, Toyota’s vice president Didier Leroy said that, despite uncertainty, “we expect growth in the long run”.
Mooted vehicle sales tax cut in China
A report by Gasgoo – which compiled the revenue and profit performances of several Chinese automakers – saw SAIC Motor [SHA] leading the race with net profits of $5bn, rising 12.31%, and reported positive year-on-year increases to profits for most of the others, including GAC Group [HKG], Great Wall Motor [GWLLF] and BYD Auto [BYDDY].
Aside from mounting trade tensions and a slowing economy, China’s car manufacturers are set for an upward trajectory. Rather than sales falling off a cliff, the market is going through a structural realignment and maturing after an era of super-charged growth.
The bold new world of electric and autonomous vehicles is also radically changing the terrain, and the high value of deals emphasises just how important it is for traditional automakers to diversify – through, for example, acquisitions – and leapfrog into the sharp end of this market.
Total value of M&A deals made in Q3 2018 – the highest since 2008
Some estimates suggest there will be 125m electric cars on the road by 2030. In 2017, 50% of car sales in Norway were electric, and China is on track to sell 1m electric vehicles by the end of 2018. Aggressive subsidies in the country means it accounts for 35% of electric cars sales worldwide.
While the macro outlook doesn’t look encouraging, there are glimmers of hope. Sales of traditional passenger vehicles in developed markets may be weakening, but the market for luxury cars could provide a welcome respite for automakers with strong brands.
The downturn in US sales has been tempered by growing demand for luxury SUVs and trucks, which command much higher prices and are more profitable for car makers.
Ford SUV sales were up more than 31% from 2017, and for 2019 the carmaker is due to roll out new versions of its Explorer and Escape – Ford’s two highest-volume models in the crossover/SUV market.
In order to maintain this growth area, manufacturers are increasingly developing luxury electric SUVs to compete with Tesla [TSLA]. The close of 2018 saw BMW and Jaguar move into the space, while Audi, Volkswagen and Mercedes will launch their offerings in 2019 and 2020. Ford will also release 13 electric vehicles over the next five years as part of a $4.5bn investment.
Furthermore, while the volume of automotive M&A deals declined in 2018, deals reached the highest value in 10 years for Q3 – a cool $59.3bn. This suggests there are plenty of companies in the market aiming to get ahead of the game or consolidate their share of the market.
New legislation and rising costs
In September 2018, the introduction of the Worldwide Harmonised Light Vehicle Test and new environmental stipulations took its toll on BMW, Mercedes and Volkswagen, whose emissions scandal brought the legislation into effect.
The introduction of the emissions test has forced car manufacturers to halt deliveries, causing the European car market to suffer the biggest monthly decline in a decade: in September 2018, year-on-year sales dropped 8.5%, and there has been a moderately paced decline ever since.
Brexit negotiations, Italy’s weak economy, rising material costs, developing electric cars and volatile fuel prices have also played a role in the problems.
Fasten your seatbelt
The automobile industry is a paean to globalisation. And, as with all technological change, there will be winners and losers. Traditional carmakers will have to innovate to survive this new market environment. Much like Ford’s trailblazing T Model, the successful cars of tomorrow will have to upend traditional business models and, as they do, ripples will be felt far beyond the auto market.
Two pockets of the market are holding up: electric cars and luxury brands. Elsewhere, in China for example, a slower ride can be a smoother ride. Investors must ensure they’re driving in the right lane.
The electric: Tesla & NIO
In a surprising turnaround, Tesla smashed estimates for its Q3 earnings, making it only the third profitable quarter in 15 years. The electric carmaker’s stock has since soared as orders for its Model 3 begin sales outside the US. However, the maker will need to continue the trajectory to justify its high valuation: while it is projected to sell 220k cars in 2020, VW, for example, already sells triple that a month and expects to sell 1m electric vehicles per year by 2025.Tesla 1-year share price performance, CMC Markets, as at 25 January 2019
Revolutionising the high-end automotive industry in China, NIO [NIO] is seen as a lifestyle brand in the east with its dealerships more like social clubs than sales hubs. Its premium electric car will also benefit from China’s environmental push, as licences for electric cars are free and open to anyone.
The Germans: Daimler & BMW
Daimler has had a few dented past earnings results, going so far as lowering its full-year guidance for its overall earnings to significantly below the $10bn it earned in 2017. It will now be looking for its powerful new line of electric cars to provide a much-needed boost.
BMW is one of the top luxury car brands in the world, but its stock hasn’t been performing well, falling nearly 15% since the start of 2018. The Munich-based carmaker was one of the few automobile companies that was prepared for the emissions crackdown.
The Americans: GM & Ford
General Motors had a rollercoaster 2018. Despite strong earnings throughout, rising costs in materials in the US and currency devaluations in Argentina and Brazil have both impacted its bottom lines. But a restructuring plan announced late in November 2018 – including slashing staff and cutting car models – has pricked investors’ ears.
Ford’s profits declined sharply in 2018 – its adjusted EBIT was down 12% in Q1, 39% in Q2 and 26% in Q3 compared to 2017. It remains to be seen if the Michigan-based car manufacturer stays competitive in an increasingly autonomous and electric car world.
The CMC View
“Volkswagen AG is home to huge brands such as Ferrari, Audi, Bentley, Bugatti, MAN trucks and Porsche – but the company is only valued at €73bn. At a price-earnings-ratio of 5.6, investors do not have to pay an exorbitant amount relative to the earnings per share on offer. On top of that, Volkswagen pays a dividend of 2.7%, has a cash balance of over €22bn and expects to get another €7bn from an IPO of its truck business.
The low valuations of Volkswagen – and of other German car manufacturers – are likely because of doubts about whether they are ready to provide the market with answers to what transportation might look like in the future. For anyone hoping that the German auto industry will provide the market with those answers, it could be an interesting time to look at the German auto shares more closely.”