Automotive - Euler Hermes

Euler Hermes | September 2015

Key Points 1 E uler Hermes expects further growth in automotive sales of 4% in 2015, to 17.5 million vehicles; the decline of unemployment and gas prices as well as the improvement of consumer confidence are playing key roles in the increase. 2 F or 2016, U.S. light vehicle sales could potentially peak or slightly decline by 1% vs. 2015 due to an expected interest rate hike. 3 L ow-cost, foreign auto manufacturers are continuing to take market share from Ford and GM down 25.5 bps year-over-year compared to July 2015. 4 T he MPG of vehicles could increase by 70% by 2025 due to U.S. CAFE, the shift to aluminum parts, and the electrification of vehicles. This should benefit the automotive suppliers that are able to innovate and provide value-added, fuel-efficient products.

Automotive

In collaboration with Yann Lacroix Sector Advisor for Automotive and Steel [email protected]

Overview – Strong growth expected for 2015, with a potential peak in 2016 due to increased cost of credit 2015 marks a strong year for the automotive industry as growing consumer confidence and lower unemployment are driving increased light vehicle sales to an estimated 17.5 million vehicles for 2015. Though we continue to see a weak price environment for oil and gasoline, a slight increase in prices could hamper growth for 2016. However, the real risk lies with the Federal Reserve and the potential rate hike, which could cause higher cost of credit for consumers. We therefore forecast sales to be down 1% in 2016. The U.S. Corporate Average Fuel Economy standards (CAFE) are also a game changer: They require auto manufacturers to increase vehicle fuel-efficiency annually to a designated target by 2025. As the MPG requirements become more stringent, auto manufacturers will be required to innovate and develop new ways to make vehicles lighter and more fuel-efficient. This will lead to the increased use of aluminum in lieu of steel and the increased use of electricity to power vehicle processes. These changes should drive increased sales for auto suppliers who are able to develop products to support this industry shift. Increased profitability for auto manufacturers has been driven by the change in the trend of light truck sales relative to car sales through July 2015 as compared to YTD July 2014. As light trucks carry greater than 100% higher margins, this should help drive earnings growth for auto manufacturers should this trend continue.

Current Environment – A declining unemployment rate, increased consumer confidence, and low gasoline prices continue to drive increased light truck and car sales As shown in Table 1, for July 2014 CYTD (calendar year-to-date), 0.95 light trucks were sold for every car; this has been a changing trend for July 2015 CYTD, where for every car sold, 1.06 light trucks have been sold. Table 1: Sales of Light Trucks vs. Cars 2015 CYTD

2014 CYTD

Total Number of Cars Sold

4,867,583

4,923,909

% Change -1.14%

Total Number of Light Trucks Sold

5,164,938

4,675,375

10.47%

Ratio of Trucks to Light Cars

1.06

0.95

11.75%

Average Gas Price (Regular)

$2.73

$3.66

-25.41%

$54.31

$105.23

-48.39%

6442.616

6145.440

4.84%

Average Crude Oil Spot Price Construction Payrolls

Source: Autodata, YahooFinance, Federal Reserve Bank of St. Louis Euler Hermes

Industry Outlook:

Ryan Maluski, Credit Analyst [email protected]

The main driver for the increase in the sales ratio of light trucks to cars was the cross-over vehicle segment. The increase in July 2015 CYTD sales in the cross-over segment was 14.3%, to 2.5 million units. This change in trend is beneficial to auto manufacturers as light trucks come with higher margins and can be attributed to two main factors: Oil price declines, which drove gas prices 25.41% lower, and increased construction spending. This is a benefit for light truck manufacturers as light trucks generate greater than 100% higher margin than cars and therefore increase profitability. As the unemployment rate continues to decline (down 45%) from a high of 10% in October 2009 to 5.5% as of May 2015 (see Chart 1), a greater number of Americans are employed. This is driving the increase in total vehicle sales at its pre-crisis level. However, while lower gas prices were a driver in light truck sales this past year, it is not as strong a driver as the unemployment rate in increasing total vehicle sales. Another indicator is consumer confidence, as shown in Chart 2. Increased consumer confidence — up 277.1% from the February 2009 low of 25.3 to 95.4 as of May 2015 (Consumer Confidence Index) — continues to drive vehicle sales higher as consumers feel more comfortable purchasing big-ticket items. These two drivers have been and should continue to be tailwinds for auto manufacturers going forward. Conversely, the optimism for these increases is somewhat muted due to the increase in subprime loans, up to 8.3% of all new car loans during June 2015. These subprime loans carry interest rates of 10% or greater, and the U.S. Justice Department and other agencies are currently expressing concerns about the risk of extending these subprime loans to higher-risk borrowers.

Source: Federal Reserve Bank of St. Louis, Euler Hermes

Chart 1: Lower Unemployment and Declining Gas Prices Driving Increased Car Sales

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Source: Conference Board, Federal Reserve Bank of St. Louis, Euler Hermes

Chart 2: Consumer Confidence and Light Vehicle Sales

Many consumers are demonstrating their preference for foreign manufacturers as Ford and General Motors continue to lose market share in the U.S. to foreign manufacturers. As shown in Table 2, Ford and GM have lost a combined 25.5 bps of market share from July 2014 to July 2015 while foreign auto manufacturers have gained 39.5 bps of market share. Another example of the weakness shown by U.S. auto manufacturers was Chrysler’s purchase by Italian auto maker Fiat, which began buying Chrysler stock during The Great Recession as a joint rescue of Chrysler and supported by both the U.S. and the Canadian governments. To stay competitive and to maintain market share, Ford has reacted by instituting a plan to reduce vehicle platforms, which is expected to decrease manufacturing time and reduce structural costs by $14 to $15 billion. This will drive increased operating margins with a target of greater than a 550 bps increase from current operating margins as of December 2014. Table 2 shows the growth (or decline) in Calendar YTD July 2015 of light vehicle deliveries and the growth (or decline) in market share year-over-year for the major auto manufacturers selling in the United States:

Company Name General Motors Corp. Ford Motor Company Toyota Motor Sales U.S.A. Inc. FCA US LLC American Honda Motor Co. Inc. Nissan North America Inc. Hyundai Motor America Kia Motors America Inc. Subaru of America Inc. Volkswagen Group of America Inc. Other Auto Manufacturers Total Light Vehicle Sales Ford & GM Foreign Auto Manufacturers

2015 CYTD

1,712,028 1,476,824 1,381,409 1,187,790 875,344 825,929 431,445 349,722 283,722 310,429 764,642

3.9% 2.3% 4.9% 6.1% 2.7% 5.0% 2.5% 5.0% 13.8% 2.8% 6.9%

2015 CYTD % of US Market Share 17.72% 15.05% 14.44% 12.56% 8.96% 8.65% 4.41% 3.66% 3.22% 3.18% 8.15%

10,032,521 9,599,284

4.5%

100.00%

100.00%

0

3.9% 5.3%

45.34% 52.67%

45.59% 52.28%

-25.53 39.52

1,778,057 1,510,333 1,448,621 1,260,170 899,325 867,355 442,163 367,263 322,935 319,102 817,197 4,548,560 5,284,560

2014 % CYTD Change

4,376,642 5,018,423

2014 CYTD % of US Market Share 17.83% 15.38% 14.39% 12.37% 9.12% 8.60% 4.49% 3.64% 2.96% 3.23% 7.97%

Market Share ∆ YoY (bps) -11.2 -33.0 4.9 18.7 -15.5 4.1 -8.7 1.8 26.3 -5.3 18.0

Percent change calculation based on numeric comparison, not adjusted for selling days in period.

Outlook – Increasing profitability for auto manufacturers offset by macroeconomic and industry headwinds In addition to the pending interest rate hike and gasoline prices, several key factors are driving our light vehicle sales forecast of 17.5 million vehicles for 2015 and the slight decline of 1% for 2016. In many markets, exchange rates are market-determined and impacted by


Source: Autodata Corp, Euler Hermes

Table 2: U.S. Light Vehicle Deliveries Calendar Year-to-Date (July 2015)

different macroeconomic and policy factors. The ending of asset purchases by the U.S. Federal Reserve, shifts in capital flows, unstable non-domestic policy environments, and exchangerate volatility will all continue to have a negative impact on the sales and earnings of many globalized companies throughout 2015, particularly as the US Dollar gains more strength. Additionally, pricing pressures are a major concern in the automotive industry. Excess capacity in manufacturing in all areas of the world and the constant introduction of new products in key segments will continue to reduce manufacturers’ ability to increase prices. Going forward, strong competition and excess capacity will continue to put pressure on auto manufacturers’ pricing power. Conversely, vehicle profitability is a tailwind as the sales ratio of light trucks to cars continues to increase due to faster growing light truck sales. As a result, margins should continue to improve as light trucks generate over 100% higher operating margins versus cars. With the use of more fuel-efficient parts and the low-price gasoline environment, sales have increased in this segment relative to smaller cars and should therefore drive increased profitability for auto manufacturers.

Opportunities – New environmental standards create constraints and opportunities Although the CAFE standards were updated in 2011, the goal remained the same: improve the fuel economy of vehicles on the road. As of 2012, the average fuel economy for new vehicles was required to be in the range of 27 MPG to 36 MPG based on the wheelbase of the vehicle. Each year, these requirements will become more strict until 2025, when the required range will be 47 MPG to 61 MPG depending on the size of a vehicle’s wheel base.

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Due to the government-required MPG improvements, auto supplier parts and innovative products that can improve fuel efficiency will be in higher demand going forward and a key driver of sales for auto parts suppliers. Contributing factors for auto manufacturers in making more fuel-efficient vehicles will be the use of lighter materials such as aluminum bodies as opposed to steel, and the increase in electrical processes used to power vehicles (electrification), which will decrease a vehicle’s gasoline consumption. Auto manufacturers and suppliers must also navigate through potentially-volatile commodity markets as aluminum prices are currently down 27% to $0.70/lb. from a 52-week high of $0.96. This type of volatility may reduce margins as hedging costs are incurred. The expected savings of the U.S. CAFE standards are approximately 80 billion gallons of fuel consumption by 2025 and 160 billion gallons of fuel consumption by 2050 (Department of Transportation).

What this means for your business – Continued caution as globalized companies experience weaker markets than the expanding U.S. market As the unemployment rate, consumer confidence and light truck sales all improve, auto manufacturers should see increased profitability going forward. On the contrary, as the U.S. CAFE standards continue to improve MPG requirements for vehicles, they will likely drive increased demand for fuel-efficient parts and products from auto suppliers. But they could also potentially increase R&D costs for auto manufacturers. Based on these standards—and in addition to current macroeconomic headwinds such as currency risks, pricing pressures and excess capacity—caution must be used in extending credit to globalized companies.
