There were numerous interesting takeaways from the Wolfe Research Auto Conference in Detroit, including revealing insights into recent shifts amongst U.S. New Vehicle Buyers (there may be less risk to industry mix than we perceived), the trajectory of battery costs, insights into Powertrain plans being made by Auto OEMs, and revelations on the Ride-Share business model. All of these have long term implications.
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No surprise, Ford announced the beginning of what is likely to become a major restructuring plan for its underperforming European business. Details are sparse. Ford did not provide any info on the cost (restructuring in Europe can cost $350k/head) or timing of benefits (we would not expect achievement of Ford’s 6% margin target until 2021, at the earliest). Per Ford’s release, they are “accelerating key fitness actions and reducing structural costs. In parallel, the fundamental redesign will include changes to Ford’s vehicle portfolio, expanding offerings and volumes in its most profitable growth vehicle segments, while ... addressing underperforming markets.”
The Market is bracing for challenges as we transition to 2019, including lower Auto Production (particularly in China and Europe during 1H19), higher Rates (which raise concerns about Mix, Pricing), the strong U.S. Dollar, Regulatory Content, unpredictable Government Policy/Tariffs, the burden of increased Spending on Technology with uncertain returns, and in some cases discontinued passenger car products.
Most major U. S. OEMs and Suppliers will provide 2019 guidance in mid- to late-January… at our Detroit Auto Show Conference (Jan 15-16), or when they deliver Q4 earnings late January/early February. Management teams are pulling these forecasts together now. And they are doing so amid an unusually large number of market uncertainties (i.e. China, Europe, and NA production; company specific concerns for Ford (China, UK), JLR (China, UK), GM (discontinuing models), and local Chinese OEMs (declining at a double-digit rate in their domestic market). Based on our discussions with Industry Management teams we suspect that most will incorporate an extra dose of conservatism into their 2019 Guides. We are fine-tuning our estimates for Lear, Visteon, and Autoliv as we intend to take the same tack (e.g. today, we are fine-tuning our 2019 net new business backlog estimates, initially provided in early 2018, to reflect updated market and FX assumptions). See pages 3-6 for more details.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
Late Sunday night (12/02/18), President Trump tweeted that China had agreed to reduce the tariff on vehicles produced in the U.S. and exported to China (China had increased this tariff from 15% to 40% in August). In addition, the U.S. will refrain from ratcheting up tariffs (would have gone from 10% to 25%) on $10.4 bn of Chinese made Auto Parts that are imported to the U.S. Although we have no detail as of yet, and these actions are contingent on the U.S. and China making progress towards a permanent trade agreement over the next 90 days, this development could have meaningful positive implications for U.S. Automakers and Suppliers:
The $6 bn cash flow savings ($4.5 bn operating cost and $1.5 bn capex) is so large, that we find it increasingly unlikely that GM’s free cash flow will moderate (ex-working capital), even in a deep downturn. The most common questions from investors: 1) What’s the “real” net cost reduction? 2) What are the chances GM will be forced to reverse course? 3) What are the implications for Ford?
We attended Ford’s analyst day in Miami and we came away impressed in two areas: 1) Ford’s AV tech appears to be competitive with the (small number of) world leaders in this arena, and; 2) We were impressed with the work Ford has done in developing platforms to commercialize this business. We acknowledge that these observations may not have near-term implications for Ford’s shares. We fully expect the equity market to focus on more near-term challenges. But OEM efforts in this arena are nonetheless critical, as we continue to believe that this Industry will face significant disruption over the next decade. AVs will play a major role in upending the value proposition that Auto OEMs have offered to consumers for the past 100 years. OEMs that lead in AV technology AND a plan to profitably deploy have an opportunity to build a business that shareholders will value highly (Ford’s AV LLC is already being set up to accept external capital and eventually go public). OEMs that fall behind in this arena will be susceptible to further erosion. We now consider Ford as part of the very small cadre of OEMs in the first category and we would not be surprised if they attract outside investments in the near-term. Here are some preliminary takeaways:
Once a quarter, we comb through corporate filings and summarize the most noteworthy datapoints. At a high level, developments during the quarter reinforced our view that investors should be Underweight Autos and Auto Parts, Underweight Dealers, and Overweight a relatively small selection of companies that fall into the Auto 2.0 category. In our view the U.S. Auto Cycle is in its 8th or 9th inning, with looming pressures on vehicle affordability. China is experiencing its first real Auto Industry downturn, and we are not convinced that the Central Government will step in to specifically prop up Autos. Europe also faces a number of challenges: These include potential trade risks (7% of Europe produced vehicles are exported to the U.S.), political risks (Brexit), and regulatory risks (vehicles more expensive to produce, at the same time that pricing has become more challenged).
GM and FCA recognized years ago that scale and breadth are far less important than focusing on fewer, inherently more profitable businesses, brands, and regions (i.e. those that have pricing power). Ford’s strategy did not apply the same level of scrutiny to returns on investment. And it’s now clear that this left the company in a strategically weakened position. That said, Ford’s narrative is clearly changing. They’ve been re-directing their spending towards more lucrative segments, and they’ve been working on plans to exit products, segments, and regions that are structurally challenged.
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