Earnings hold firm
The earnings of auto manufacturers and suppliers have held up surprisingly well this year. While earnings in Q2 were weak and leverage remains high, global lockdowns and associated production shutdowns means this is to be expected. During this period, all auto firms announced measures to preserve liquidity – including cost cutting, a reduction in capital expenditure and putting dividends on hold – and withdrew guidance for this financial year.
US auto manufacturers have clearly worked hard since the global financial crisis to decrease their breakeven points to 10-11m SAAR (car sales at a seasonally adjusted annual rate). Performance in Q2 allowed us to see just how much effort auto manufacturers had put in: for example, GM almost reported a profit in North America, despite the fact that volumes were down by 60% in the region over the second quarter.
Since then, most players have reported strong Q3 performance and display robust liquidity. Profit margins for auto manufacturers in North America have been well above 10%, driven by the product mix and pricing power. Cash-flow generation was also very strong, helped by working capital.
Yet while car sales have mostly held up this year, there is a question mark over what happens when government incentives slow down. Both America and China’s auto markets have been supported by stimulus and incentives in recent years, while recovery in the European market is lagging as the incentives remain mostly focused on cleaner vehicles.
Pressure to act
Despite the pressure on profits, cash flows and sales this year, auto manufacturers and suppliers continued to invest heavily in mega trends – including EVs.
This is largely due to increasing regulations and moves by governments across the world to ban the internal combustion engine (ICE). Transport is the largest source of CO2 emissions, with cars the greatest contributor within the sector. While some countries have remained silent on ICE bans – Germany, for example – others have not. The ICE will be banned in Norway by 2025, China by 2035 France by 2040 and, according to recent headlines, the UK by 2030.
Regulations have also stepped up. The European Union has the strictest targets and aims to reduce CO2 emissions by 50% by 2030, with other targets for 2021, 2025 and 2030. People could receive super credits for cars sold with emissions below 50 grams of CO2 per km, while manufacturers will also have the potential to pool together so that their combined fleets meet CO2 targets.
Meanwhile, China remains heavily focused on reducing air pollution through new energy vehicles. The China 6 standards regulation means that it aims for for EVs (including hybrids) to account for 20% of auto sales by 2025 and 50% by 2035.
While there is still no regulation at the federal level in the US, President-elect Joe Biden plans to spend $2trn on environmental measures over the next four years. This involves an increase in EV rapid-charging stations, a plan to reinstate the tax credit on EV purchases and the intention for 100% of sales to be of zero-emission cars by 2035.
Change on the horizon
Despite this increasing pressure, EV penetration remains limited. In 2019, EVs accounted for less than 1% of all cars sold for most manufacturers.1 Yet there has been progress this year and penetration has reached close to 10% in France, the UK and Italy.23
Limited penetration is largely due to high barriers to entry. For consumers, charging time, a lack of infrastructure, preference for SUVs, high prices and a limited number of models are all problematic. Nonetheless, progress is being made on all these fronts as manufacturers work on technology to improve range and charging time. Prices will likely fall, and models are coming to the market quickly: GM is looking to launch 30 EV models by 20254 and VW aims to release 70 models by 2030.5
For manufacturers, the problem is the cost of batteries, the need to adapt production lines and the fact that EVs are barely profitable, given the high investment needed. VW announced it will spend €35bn on EV by 2025,6 while GM said it will invest $27bn over the same period.7
Nonetheless, as technology improves and the cost of batteries comes down, we expect the industry to reach a tipping point where EVs become as profitable as ICE vehicles. For example, GM recently announced that it expects battery costs to fall by 60% by the middle of the decade. It also intends to reach an ICE-level profit margin for its EV sales in the US.8 Moreover, manufacturers are entering partnerships – both between themselves and with players outside the auto industry, such as battery players – which should help reduce costs.
We believe that EV strategies are a clear differentiating factor for automakers and suppliers. Manufacturers clearly need to strike a balance between avoiding damage to their financial profile and doing what is necessary to position themselves for the future.
While many auto firms look very similar today, each firm’s respective EV plans mean that their outlooks are vastly different. Earnings may have held up amid the coronavirus-induced disruption, but only a solid EV strategy will help auto manufacturers and suppliers position themselves for a low-carbon future.