Nov 18, 2019 — Global auto sales to remain stagnant. We now expect no growth for the industry in. 2020 and 2021. Any recovery hinges on a modest revival of
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S&P Global Ratings 1 Industry Top Trends 2020 Autos Higher rating pressure on amid gloomy industry outlook What’s changed? Global auto sales to remain stagnant. We now expect no growth for the industry in 2020 and 2021. Any recovery hinges on a mo dest revival of the Chinese market, and would come no earlier than 2021 in our view. Geopolitical risks to stay for longer. An ultimate resolution of the U.S.-China trade is not in sight. Brexit uncertainty remains and the NAFTA-replacing USMCA trade agreement has not been ratified. “Fallen angel” risk increases. We see a rising negative rating bias and an increasing number of ratings in the low ‘B BB’ category, mostly for the OEMs, linked to stringent CO2 regulations and sh ifts in consumer preferences. What to look for in the sector in 2020? Co2 challenge and Brexit de velopments in Europe. In 2020 we will focus on OEMs’ powertrain mix strategy and monitor market response. Slightly higher recession risk in the U.S. Market concerns in the U.S. are all about recession risk building up toward the end of 2020, which we now estimate at slightly higher odds of 30%-35%. Uncertain recovery of the Chinese car market. Decelerating economic growth and weak consumer confidence will continue to weigh on auto sales, only partially mitigated by government stimulus effort s and clarity on emission standards. What are the key medium-term credit drivers? Free cash flow generation and conservative financial policies. We expect balance sheet protection to be high on the agenda of OEMs and suppliers in view of the protracted market uncertainty. Capacity to deliver on ambitious restructuring plans. Due to inflexible R&D and capex needs to support transition to e- mobility, many auto OEMs and suppliers need to step up other cost-reduction efforts. Ability to continue to invest in R&D. The ability to balance between product-mix improvement, cost control and investment into technology enhancement will be important rating drivers. November 18, 2019 Authors Vittoria Ferraris Milan +39 02 72 111 207 vittoria.ferraris @spglobal.com Nishit Madlani New York +1 212 438 4070 nishit.madlani @spglobal.com Claire Yuan Hong Kong +852 2533 3542 claire.yuan @spglobal.com Additional Contacts Katsuyuki Nakai Anna Stegert Eve Seiltgens Margaux Pery Lawrence Orlowski David Binns Katsuyuki Nakai Stephen Chan Chloe Wang Kim Minjib Fabiola Ortiz Fabiana Gobbi Humberto Patino
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 2 Ratings trends and outlook Global Autos Chart 1 Chart 2 Ratings distribution Rating s distribution by region Chart 3 Chart 4 Ratings outlooks Ratings outlooks by region Chart 5 Chart 6 Ratings outlook net bias Ratings net outlook bias by region Source: S&P Global Ratings. Ratings data measured at quarter end. Data for Q4 2019 is end October, 2019 Due to weakened market momentum and no sign s of an upturn, the rating outlook for the global automotive sector (both OEMs and supp liers) is turning increasingly negative. We expect this trend to continue in the current quarter. The rising negative outlook bias reflects higher operational an d financial difficulties amid macro uncertainties, and an evolving and more challenging competitive land scape. This trend coul d be exacerbated if the global demand softness turns out to be we aker or longer than we currently anticipate. Cushions in financial risk profiles and liquid ity for some larger players has so far offset these challenges to a certain extent however.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 3 Auto OEMs Key assumptions 1. Virtually no growth for global auto markets over 2020-2021 Global economic growth is likely to continue to moderate during the next one to two years, as weak manufacturing activity and geopoli tical tensions hurt consumer confidence, holding back purchases of big-ticket items. We have therefore lowered our assumption for light vehicle sales in the major markets and we expect vi rtually no growth in global light vehicle sales over the next two years. 2. Topline growth mainly relying on product and pricing mix effects With soft demand and dim prospects for volu me growth, automakers need to speed up new-model launches and optimize product mix to protect pricing power and expand their revenue base. Stricter environmental regulati ons drive new product pipelines in Europe and China where competitive pressure will rise . In the U.S., automaker profits will remain highly dependent on the truck segment (CUVs, SUVs and pickups), which will continue to dominate the market. 3. Limited chance of margin uptick over the next two years We expect a combination of factors, incl uding intense industry competition, trade disputes, higher production and R&D costs fo r electrification, and high restructuring costs, to keep margins under pressure for automakers. The march toward 100 million global annual vehicles sales has slowed Sales of global light vehicles (passenger cars and commercial light vehicles) fell a cumulative 5.6% in the year to Sept. 30, 2019, with the most relevant decline observed in China (i.e. -10.3%, according to LMC). Sale s declined in all major markets with the exceptions of Japan and Germany, which reported pick-ups of 2.5%-3.1%. Economic conditions have worsened globally as a result of the trade war between the U.S. and China. The risk of a prolonged German weakness and a recession in the U.S. will further dampen consumer confidence and, co nsequently, prospects for auto sales over the next two years. In light of current cond itions, global auto manufacturers’ hopes for ever-increasing sales in 2020 and 2021 now appear to be dashed.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 4 Map 1 2018 light vehicle sales (mil.units) Source: S&P Global Ratings We now expect global light vehicles sales growth of 0% -1% over 2020-2021. Across the main markets we see: Modest China recovery (1%-3% growth): After two decades of rapid development stirred by supportive government policies, China’s au to market is unlikely to see a return to hyper-growth any time soon. We anticipate decelerating economic momentum, higher household leverage, and slowing disposable income growth will continue to exert a negative influence on consumer sentiment. Nor do we expect much in the way of targeted stimulus, given local governments’ fiscal constr aints, and the central government’s larger tolerance for economic slowdown. Flat vehicle sales volume in Europe (West an d East): Despite increasing concerns over economic conditions next year in Germany–w hich has so far been the only growing auto market in 2019 (+2.5% in September year -to-date according to LMC)–a further deterioration of the trade balance is less likely . Brexit remains a source of uncertainty in Europe mainly because we don’t spot prog ress on any trade-rela ted agreement between the EU and the U.K. Given the U.K. market ha s been shrinking for the past three years, however, we are confident of a stabilization at least, absent a no-deal Brexit. Downside risks to European growth remain; for exampl e if there were a surge in unemployment, though this is not our base case. 1%-3% volume declines for the U.S.: For the U. S market, we anticipate light-vehicle sales volume will drop by nearly 3% year-over-ye ar to 16.4 million units in 2020 and further to 16.3 million units in 2021, the lowest level since 2014. This is anchored on a higher probability of an economy re cession (12 months out) to 30%-35%, compared with our previous assessment of 20%-25% in May.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 5 Chart 7 Geopolitical Risks Source: S&P Global Ratings Topline growth mainly relying on product and pricing mix effects With volume growth out of sigh t, automakers will depend on refreshing the product mix to defend pricing power and topline growth. An offensive of hybrid and battery electric vehicles will hit the European market as from 2020, with Volkswa gen (across segments) and Tesla (in the premium segment) iden tified as the competitors to beat. The EU is heading toward a material tighteni ng of CO2 thresholds in 2021 (average for the market CO2 95g/km). This raises the question of whether the market will be ready to absorb the number of low-emitting vehicles th at OEMs need to deliver in order to comply with their company-specific targets. The combination of increasing regulatory costs and soft market conditions will be to ugh for Western Eu ropean markets. In the U.S, we expect rising demand for li ght trucks–including SUVs, CUVs (crossover utility vehicles), minivans, and pickups–wi ll lower passenger car sales to about 30% of total LV sales in 2019 and 2020 co mpared with over 50% in 2012. Automakers are set to shrink their passenger car expo sure further, in our view. In China, we expect aver age topline growth of 2%-4% for OEMs in 2020-2021 driven mainly by product launches that target the higher-price ran ge. Premium brands such as BMW, Lexus or Daimler outperformed in 2019, with estimated volume growth of around 10% in the first nine months of 2019 (Sou rce: China Passenger Car Association). We expect the trend to extend in to 2020, on the back of cont inuous consumption upgrades and the penetration into the mid- to high-e nd market of localizing compact models. Limited chance of margin uptick over the next two years With only a few exceptions, OEM operating margin s generally took a hit in the first half of 2019 already and issuers are guiding for stabilit y, at best, of profit ability and earnings. Ongoing restructuring costs and non-deferrable investments in technology upgrades will make it very hard to improve profitability. Our forecast of slightly rising margins in 2020 versus 2019, is mainly driven by our view of non-recurring costs next year, such as litigation related costs.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 6 The electrification megatrend brings with it a squeeze in margins, driven by high unit costs linked to batteries and the economic costs of massive investments over recent years. Chart 8 Average battery price over the years ($/kWh) Source: Bloomberg NEF Adding to uncertainty of market acceptance of electrified mobility is the lack of an extensive and far-reaching policy framework su staining the transition in Europe. The cost of this transition weighs almost entirely on the industry and on its average profitability. In the U.S, electrification is nowhere near as imminent or significant. We still see chances of a modest improvement in pr ofitability for U.S. automake rs relative to 2019, due to global rollouts of new truck platforms over th e next 24 months, ongoing cost reduction, and restructuring actions. Slowing demand will intensify price competition for their products, across the globe. We also incorp orate increasing engineering expenses for technology advancement in relation to autono mous driving, mobility, and electrification– which will limit profitability improvement beyond 2021. In a stabilizing market in China, margins of the overall industry will remain under pressure from intense competition, due to th e wider availability of new energy vehicle (NEV) models. We expect some benefits to derive from higher R&D and capex synergies with global OEM partners targeting localiza tion of NEV models. At the same time, we expect Chinese OEMs to introduce new propri etary models that target a higher price range, dispose of nonperforming proprietar y brands, and to improve utilization by realigning production capacity. In addition, we expect largely stable dividend income from their joint ventures with global OEM partners , which is a large component of EBITDA for some companies.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 8 (albeit unlikely), would have an adverse impact on automotive demand because most of these costs will be passed on to consumers. At this point, we see a limited effect on th e ratings of U.S. automakers Ford Motor Co. (BBB-/Stable/A-3) and General Motors (BBB/Stab le/–) because of thei r lower reliance on exports and higher level of localized content relative to foreign automakers. An indirect effect could be the challenges for U.S OEMs to seek growth due to tariff pressures and potential nationalism leading to anti-Ame rican sentiment in the China market. For California-based Tesla (B-/Positive/–), increased tariffs would add significant incremental margin pressure. Incorporating Tesla’s overseas transport costs and import tariffs raises, the company operates at a 55% -60% cost disadvantage compared with the same car produced in China. Also, the tr ade war increases the likelihood for higher import duties on certain components used in Tesla’s products that are sourced from China, which would further pr essure margins. However, we expect tariff pressures to lessen once Tesla begins production at the Gi gafactory. Also, we project lower costs from more simplified production processes and a local supply chain. Industry transition to CO2 neutral mobility sees challenges In Europe, the transition to CO2-neutral mobi lity is exclusively driven by regulation. Increasing penetration is well under way in countries with generous subsidy schemes and favorable tax regulation, whic h substantially diverges from country to country. OEMs need to deliver on regulatory diktats and create the market demand for electric cars. Regulators will not put targets on hold to accommodate weaker market conditions. Thus cost reduction measures will not likely extend to R&D and capex in our view, and the benefits of ongoing restructuring could take longer time to materialize. European frontrunners in electrification typically spend the equivalent of 6%-10% of auto revenues on R&D per year, and 5%-7% on capex. The Chinese government has set a target for NEV sales to account for 20% of total auto sales by 2025, from the current 5%. This means a compound average growth rate of around 25% during the period (assuming no gr owth in total auto sales from 2022), which we deem ambitious. Can the market absorb th is shift? A majority of NEVs are sold to business customers (such as car hailing/rental companies). This trend has some support in large urban areas, where mobility services are gaining appeal as an alternative to car ownership. However, a lack of charging-sta tion infrastructure distracts from NEVs’ appeal. The Chinese NEV market has been traditionally dominated by Chinese OEMs with all top-10 players being local manufacturers, an d representing over 70% of market share. Most of them have a focus on battery-energ y vehicle and target the lower price range. These OEMS will face mounting competition fr om other technologies and mid- to higher- end models, after NEV subsidy withdrawal in 2020. Foreign OEM brands could start to gain traction in this field due to their battery and vehicle technology strength. The anticipated launch of mass production of the Tesla Gigafactory in Shanghai in the fourth quarter of 2019 will likely kick off such competition. In the U.S. market, we expect the combined sh are of electric vehicles (including plug-in hybrids) to remain under 3% of overall auto sales in 2020 despite significantly increased sales for Tesla’s models 3, S, and X. This will lead to some market-share losses for some competitors in alternate fuel segments. Beca use of ongoing customer concerns regarding range, price, and charging infrastructure, we expect some downside risks to our prior base-case assumption, under which electric ve hicles (including plug-ins) approach 10% of light-vehicle sales by 2025. Customer concerns are compounded by the falling cost of ownership for non-electric vehicles, given lo wered gas prices, reduced tax incentives for cleaner alternatives, and the high likelihood that the Trump administration will roll back fuel-efficiency ta rgets for 2025.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 9 Full mergers vs partnerships We had anticipated industry consolidation as a response to disruption. Europe faces among the toughest market dynamics over the next two years, and has one of the highest concentrations, given the two largest OEMs control 40% of the market. In a no-growth environment characterized by punitive regula tion, pressure on ma rgins and technology disruption, cost management and delivery on strategy can become overly challenging and push OEMs toward strong partnerships (VW- Ford) or full mergers (failed Renault-FCA attempt followed by merger talks between FC A and Group PSA). We see a sound rationale in this trend provided it does not weaken balance sheets. Economic benefits from partnerships do not stand out very clearly in financial performance. One question is whether aging partnerships, such as the alliance between Renault-Nissan-Mitsubishi, can still provide a valid response to exceptional pressure on industry fundamentals. This is not just cyclical. Rather, it’s a deep tr ansformation of a trad itional manufacturing sector into a service oriented one with a strong technology content. That is whether partnerships can still provid e sufficient scale to generate material cost benefits for the parties involved. We tend to believe that in situations characterized by a dominant, large-scale player, pa rtnerships might still be viab le. Where the initial scale is lower, full-blown mergers mi ght be the better strategy to maximize synergies. In China, we’ve seen increasing risk of smaller and weaker players being phased out of the market. Yet large horizontal mergers remain unlikely in our view. Large OEMs, such as China FAW Group Co. Ltd., are se tting up car-hailing joint ventures with peers, so as to increase sales volume (especially NEV sales) and to extend their value chain vertically. This represents a new form of strategic a lliance among industry players versus the traditional merger–which coul d elicit potential resistance from local governments in consideration of local tax revenue and indu stry-chain effect. At the same time, the Chinese government would allow foreign OEM pa rtners to increase their stake in local joint ventures (JVs- to support tech transf ers). The relationship between BAIC Motor Corp. Ltd. and Daimler was further enhanced this July through the acquisition of a 5% stake in Daimler by BAIC Motor’s parent, Beijing Automotive Group Co. Ltd. (BAG). As China is the only single market where we see the potential for growth, we believe tightening partnerships and larger stake in JVs are credit supportive. We expect the U.S. automakers to collab orate on battery development for electric vehicles and autonomous driving capabiliti es. GM and Honda will continue their joint development of a new purpose-built shared au tonomous vehicle. The companies’ ability to leverage its recent investments in these areas would be an upside to our base-case forecast assumptions beyond 2021. Until then, we view it as neutral to the credit rating, assuming GM spends approximately $1 billio n in the GM Cruise segment in 2019. Ford’s recent announcement that it will share co sts and expertise on design and engineering with Volkswagen–to develop commercial vans and pickups globally and also its access to Volkswagen’s MEB electric vehicle platform– will help Ford to overcome delays in its electrification roadmap.
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 10 Auto Suppliers Key assumptions 1. Limited growth in auto suppliers’ topline in the next two years Global light vehicle sa les will fall short of 100 million annual sales– by approximately 8 million in 2020. We expect vi rtually no growth for 2020 and 2021, thus constraining revenue growth for suppliers. 2. Supplier margins under pressure Declining volumes, intensifying price competit ion, foreign exchange vo latility, rising raw material costs, and restructuring costs make it harder to meet business plan ambitions over 2019. We anticipate margins will rema in under pressure throughout 2020 and 2021, provided no meaningful recove ry of industry conditions. 3. Financial policy decisions likely to shape credit profiles We expect negative rating pressure in the down cycle, but financial policy can be a decisive factor for credit quality. A limited scope to grow revenues Our flat unit auto sales foreca sts for 2020 bodes ill for auto suppliers. That said, we see some potential for revenues to stabilize in 2021. In line with unit sales trends, we expect the highest decline in auto production in the Chinese market–at 7%-9% in 2019. A number of OEM volume producers have drastica lly restructured their operations in the Chinese market, including by taking out pr oduction capacity. Suppliers with a high percentage of sales from China and heavy exposure to volume producers such as General Motors, Ford and PSA should particularly f eel the impact in 2019 and the coming years; this includes Schaeffler AG, Robert Bosch GmbH, Autoliv Inc. and Valeo S.A. We also anticipate Europe an and U.S. production rates will decline throughout 2019 and 2020, but at a more moderate pace co mpared with the Chinese market. In the U.S., some rated auto su ppliers will likely increase sa les in 2020, due to the impact of pricing, mix, changes in market share, and acquisitions. For example, Aptiv PLC has been growing faster than the industry due to new programs wins, market positioning, and ability to price appropriately. Dana Inc. has grown faster than the market due in part to acquisitions and the successful conversion of backlog orders. Furthermore, tire makers and other aftermarket issuers have much lowe r exposure to auto production. The ability of these issuers to raise prices to cover past increases in raw material costs and tariffs is the more dominant factor at play over the next year. For the few rated Chinese auto suppliers, we haven’t seen or der cancelations in 2019, but order delays are quite common. In Brazil, auto sales should remain solid in 2020, recovering from the recent economic downturn. But production and sales could be hurt by falling exports to crisis-hit Argentina. This is because Argentina is the principal destination for Brazilian vehicles production. Exports slumped 35% year on year in August 2019. We expect weakness through into next year. In Mexico, the risk is slower-than-expected ec onomic growth in the U.S. This would result in sluggish consumption, and would eventual ly affect pent-up U.S. demand for light
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Industry Top Trends 2020: Autos S&P Global Ratings November 18, 2019 11 vehicles. However, we continue to expect au to sales growth at ab out 3% in 2020 from historical growth of 5%-10%, supp orting demand for auto parts. Margin threats push restructuring initiatives Dim demand outlook, increasing price compet ition, higher input costs, elevated R&D expensed, additional plant relocation cost or sourcing reconfiguration: these factors work together to the detriment of auto supplier s’ margins. Effective cost reduction and improved product mix are key defenses. A number of auto suppliers have markedly stepped up cost saving initiatives over recent quarters. Continental AG anno unced one of the biggest restructuring programs, which will impact up to 20,000 jobs worldwide by th e end of next decade. Other large global auto suppliers such as Bosch, ZF, and Schaeffler are also stepping up restructuring efforts through plant closures and headcount reductions, while imposing more stringent cost control. Nevertheless, we foresee continued ma rgin pressure for global auto suppliers as intensifying pricing pressure add to margin dilution. We also expect costs for cost restructuring programs to weigh on operating margins and free cash flow in the coming years. We see a few suppliers bucking the trend so far, such as Faurecia SE and Kongsberg Automotive ASA, which have shown more resili ence than average. We attribute this to proactive restructuring efforts in recent years, but we also note the groups lack exposure to the traditional powertrain business that dragged on other suppliers’ margins. Japan’s Denso Corp. and Aisin Seiki Co. Ltd. have also b een relatively resilient. This is mainly due to the solid business performance of Toyota. Producers with powertrain operations will like ly see continued margin pressure. This is due partly to elevated R&D expenses. Another issue is tougher pricing negotiations with OEMs, many of which face their own margin issu es, due to a lack scale on their electrified models. In the U.S., for most of our large tier-1 auto suppliers, we expect st eady profitability under our base-case, with a few exceptions relate d to firm-specific underperformance. Unless there is an economic downturn and a substant ial decline in light-vehicle demand, R&D as a percentage of sales, margins, and capex as a percentage of sales will not move that dramatically. We don’t see tariffs on Chines e imports as having a materially adverse effect on U.S. tier-1 auto suppliers. For example, suppliers such as Adient PLC (Aptiv (, BorgWarner Inc., the Goodyear Tire & Rubber Co.), and Tenneco Inc. (manufacture in the country or region where they sell and the im pact so far has not been material. Moreover, even though many firms make where they sell, they may need to move their manufacturing footprint because their customers may need to resource their supply chains at more favorable locales. The recent trend of declining U.S. imports of auto parts from China suggests that some suppliers are resourcing; moreover, these would likely be the tier-1 players who are able to tap alternative sources more easily due to their larger size and geographic reach. Smaller U.S aftermarket auto suppliers suffer more because they import a substantial percentage of their products from China. Tari ff-related disruption in the supply chain is raising manufacturing costs, slowing produc tion, and, hence diluting margins. While aftermarket suppliers are able to offset a part of the tariff impact by getting concessions from Chinese suppliers, the majority of the tariffs must be offset through price increases or sourcing from other countries. Both of these alternatives take time, and large price increases to major retailers with strong bargaining power, such as Autozone Inc. and Advance Auto Parts Inc., can be quite chal lenging. It’s true, though, that these aftermarket suppliers dependent on China fo r their components ar e similarly situated, and over a longer time period will have to pass these higher cost s to the consumer. At that point, the degree of differentiation could be the extent of sourcing from China. These
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