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Engine room: credit insights from the Detroit Motor Show

The Detroit Motor Show coincides with a smattering of industry conferences to make January a busy month in the automotive sector – and a good source of intelligence for credit investors. This time, the insights we gained reaffirmed our conviction in a long-held relative-value trade involving two giants from the Motor City.

The motor show, officially named the North American International Auto Show, is typically a good opportunity to hear commentary on the past quarter as well as industry views for the year ahead, and this year was as fruitful as ever. I’ve returned with the feeling that 2019 will be a year of challenges for the auto sector – many of which reinforce positions that we hold already.

Sales forecasts: US to ease as China brakes

Most automakers currently agree on the outlook for 2019 on a regional basis. In the US, the market was strong last year with the seasonally adjusted annual rate (SAAR) of sales registering at 17.2m for 20181. This was driven largely by positive economic data, such as rising consumer confidence and falling unemployment, along with low interest rates and strong incentives to buy a new car.

The expectation from car manufacturers and suppliers is that US SAAR in 2019 will remain healthy but that further growth will be constrained as incentives have begun to decline, interest rates are rising and residual values are expected to fall, discouraging consumers from leasing new cars.

The consensus view suggests that US car sales could slow to slightly below 17m, which remains a very high level.

To put the figure into context, General Motors (GM) and Ford have previously indicated they would remain profitable even if sales fell to 10-11m for the year. GM states that a 25% decline in US car sales should result in a 60% deterioration in its operating profit.

However, in the world’s largest automotive market of China, the picture is a little worse. The current consensus comes after 2018 saw car sales decline in China for the first time in many years.

In 2019, automakers and parts suppliers anticipate that the first quarter will continue to see weakness that may stretch into the second quarter, although sales could stabilise in the second half of the year.

While manufacturers and suppliers all mentioned that the Chinese government may be about to implement stimulus efforts to boost car sales if they fall excessively, this is not yet factored into forecasts.

Meanwhile in Europe, last year was negatively affected by the implementation of the strict new Worldwide Harmonised Light Test Procedure (WLTP) at the start of September. The impact of WLTP is now behind us and car sales are expected to stay roughly flat this year.

Red lights on the dashboard

Declining car sales were accompanied by other warning signs in Detroit.

Most car manufacturers and suppliers mentioned trade tariffs, foreign-currency movements, rising commodity costs and an intense competitive environment as potential hazards. As a result, their guidance could be seen as conservative.

Unusually, other companies including Ford, Goodyear and parts-maker Adient said they were unable to provide a view on their expected performance for 2019 – an unusual position to take at the Detroit show.

Ford said it expected to achieve potential improvements in its key metrics but provided no specific targets or measurements. The CEO of Adient was too new to the job to be comfortable enough to provide guidance. At Goodyear, industry challenges and company-specific issues were mentioned as impediments and, given its continual downgrades throughout 2018, its decision to err on the side of caution and provide no guidance in Detroit could be seen as a safe move.

Driving seat: car ‘megatrends’

Consumers’ shift away from saloon or ‘sedan’ cars towards larger vehicles such as trucks and SUVs remains a theme.

In Detroit, many companies announced large investments in the latter format. It was mentioned that once a consumer moves away from sedans they are highly unlikely to return.

American Axle, a Detroit-based driveline and drivetrain specialist, said 70% of current production in North America was now skewed towards light trucks and that 70% of its backlog linked to that type of vehicle. Ford is allocating 90% of its resources towards these larger cars.

The Detroit show came one week after the Consumer Electronics Show in Las Vegas, at which car manufacturers and suppliers had already made announcements on ‘megatrends’ affecting the auto industry: electric and autonomous vehicles, and connectivity. But we did receive new highlights about manufacturers’ electric and autonomous vehicle strategies at Detroit.

Obstacles impeding the faster development of electric vehicles and impact profitability – such as battery costs, charging time, infrastructure and ranges – remain. However, electric-vehicle production should accelerate rapidly once technological advancements are made and regulatory pressure to reduce carbon emissions increases. China is likely to be among the biggest growth regions for electric vehicles.

When it comes to autonomous vehicles, the timeline until commercial launch varied between the manufacturers and suppliers, ranging from late 2019 to the 2030s.

It was obvious at Detroit that this megatrend, along with electric vehicles and the increased connectivity of cars, should not be ignored by companies operating in the industry.

Car manufacturers were more open than usual on the possibility of forming partnerships to deliver these technologies, and GM recently said it remained open to finding another partner in addition to its work with Honda and Cruise Automation to develop an autonomous vehicle that can be manufactured at a high volume for global deployment2. Ford and Volkswagen announced a collaboration on electric and autonomous vehicles on the first day of the show.

GM: overtaking Ford

We continue to see GM as a better credit investment than Ford, an have exposure to he issuer in all of our strategies. GM has been more proactive than any of its peers on investing in megatrends that we believe will dominate in the future as sustainability prevails over existing ways of providing transportation.

GM’s CEO, Mary Barra, highlighted that the firm’s board of directors has always been very effective and supportive of its long-term sustainable strategy, allowing it to make the right investments at the right times.

In contrast, Ford’s management team publicly admits that it is behind on investing in electric and autonomous vehicles. Also, the business has been unable to provide additional details on the restructuring measures it announced in mid-2018, creating uncertainty among investors.

Ford’s credit metrics have subsequently weakened and the company is veering close to a downgrade to high-yield status. This appears to be already anticipated by the market as yields on Ford’s credit now trade close to the US BB Non-Financial High Yield index (see figure 1).

Figure 1. GM’s focus on sustainability and consumer preferences leaves Ford in the rear-view mirror

Source: Bloomberg as at 25 January 2019.

Eyes on the road

It should not come as news to our investors that we firmly believe that progressive and prudent manufacturers in electric and autonomous vehicles will benefit in the long term.

January’s information flow has reaffirmed this to us – and also that our preference of GM over Ford is an investment that fully reflects our convictions about the industry’s direction of travel. GM is making a genuine effort to prepare for the future, and is being rewarded with a lower credit-risk profile.

1Source: Autodata Corp as at January 2019.

2Comment made by GM CEO Mary Barra at the 2019 Global Auto Industry Conference on 16 January 2019.

The views and opinions contained herein are those of Ilana Elbim, Credit Analyst, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products. This commentary is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. 

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