Automotive Sector Outlook & Unfolding Collateral Damage

By Zain Khawaja

Auto-OEMs around the world are suffering deep losses due to the Covid-19 pandemic. Economic headwinds were tough for many auto manufacturers even before the start of the pandemic but the production halt of car manufacturing plants around the world during Q1 2020 means there is clear certainty of a major negative impact on many car manufacturers’ full year 2020 financials, unless there is a miraculous turnaround during the remainder of 2020.

Without waiting for miracles however, auto OEMs have moved fast to arm themselves with cash by drawing down almost all corporate credit lines that were available to them. Last month, Ford Motor Company indicated to lenders that it will borrow the total unused amounts against two of its revolving credit lines: $13.4 billion under its corporate credit facility and $2 billion under its supplemental credit facility [1]. The incremental cash from these borrowings is stated to be used for offsetting the working capital impacts of the Covid-19 related production shut downs and to preserve Ford’s financial flexibility. Ford has suspended its financial guidance for 2020, which it had released as recently as 24th February 2020. Ford has also notified the market of a suspension of dividend payments. Amidst the crisis, Ford Motor Company has also suffered an unprecedented credit shock with its credit rating being downgraded to junk status by S&P Global Ratings [2]. Ford has recently announced a further delay to the launch of its robotaxi service to 2022 on account of the “challenges of the current business environment, as well as the need to evaluate the long-term impact of Covid-19 on customer behaviors” [10]. Ford had recently invested $500 million in electric vehicle start-up Rivian and cemented a strategic partnership to develop an all-electric Lincoln vehicle as a new flagship model based on Rivian’s skateboard electric vehicle platform. Ford has now cancelled these plans, announcing that “given the current environment, Lincoln and Rivian have decided not to pursue the development of a fully electric vehicle based on Rivian's skateboard platform” [11].

General Motors is not painting a much different picture. CEO Mary Barra has said; “We are aggressively pursuing austerity measures to preserve cash and are taking necessary steps in this changing and uncertain environment to manage our liquidity, ensure the ongoing viability of our operations and protect our customers and stakeholders,” [3]. GM intends to drawdown $16 billion from its revolving credit facilities, and it too has suspended its 2020 outlook. Coming into the Covid-19 crisis GM had already suffered a $3.6 billion negative impact on earnings due to worker strikes during Q3 and Q4 2019, its China sales were declining and it was profitable only in the North American territory. In 2019 GM Cruise developed the ‘Origin’ concept vehicle and had posted negative $1 billion EBIT for full year 2019 [4]. GM has now discontinued its ‘Maven’ car-sharing service whereas Maven was previously considered a key initiative by GM to gain a firm foothold in what was seen as one of the most disruptive trends in the mobility space.

Regarding Volkswagen, Chief Executive Herbert Diess has said that VW would recover from the Covid-19 crisis with “merely a black eye”, if the “crisis was dealt with as quickly as it had been in China” [5]. Based on this idea of a quick recovery akin to the Chinese model, McKinsey still predicts that the global car industry may be headed for a deeper recession than what it endured after the 2008 financial crisis – an estimated 30% drop for 2020 across US and Europe. It is important to note that the quick recovery is itself predicated upon effective public health responses succeeding in controlling the spread of the Coronavirus within two to three months [5]. The recent production halts have affected the jobs and livelihoods of an estimated 1,000,000 auto workers across Europe and UK combined; with reduced hours or furloughs and governments footing the bill for a large fraction of their salaries, to safeguard dislocation in the very short term.

The differential high impact of a ‘quick recovery’ model versus a protracted recovery model becomes quite apparent when reviewing the most recent press release [6] of Valeo, the French automotive Tier-1 supplier. Regarding China operations and sales, Valeo have stated that; “since February 10th, production has gradually resumed at all 34 Group plants in China. Following very sluggish activity levels in February, sales in March climbed back to 60% of prior-period 2019 levels. Activity levels should return to those seen in 2019 during the second quarter”. Nevertheless, Valeo’s overall outlook, for Q2 2020 and full year 2020, has been suspended due to their stated “lack of visibility regarding when the crisis will end”. Valeo has negotiated an additional €1 billion credit line to shore up to an overall revolving credit availability equal to €2.3 billion so that they can “withstand any prolongation of the current crisis”. Valeo expressed that the global decline in automotive production during Q1 2020 was estimated at 24%, whereas the decline within China had been 49% (Based on IHS automotive production estimates). Largely bucking that downtrend, Valeo sales to auto OEMs have declined by only 8% overall during this period, and notably their best performance has been in their ‘Comfort and Driving Assist’ segment which suffered a reduction of only 2% during the quarter due to “high content per vehicle (take rates) in the driving assistance segment as well as a favorable geographic mix” [6]. Despite this performance, Valeo has decided to postpone their Annual Shareholders’ meeting from May 26th 2020 to June 25th 2020, due to “the exceptional and evolving context of the coronavirus pandemic”.

Continental AG has also withdrawn its guidance for 2020, and the company has stated that based on preliminary key data, their expected EBIT margin for the Automotive Division for Q1 2020 will be 0%. Continental AG have shared with the market that they currently have cash and cash equivalents of €2.3 billion as well as access to a committed revolving credit line of €4.6 billion. In response to the Covid-19 crisis, the company is “implementing numerous measures to adapt costs and reduce demands on liquidity. This includes actions to adjust working times as well as wage and salary costs. Specifically in Germany, as of April 1st, 2020, approximately 30,000 employees (around half of the local workforce) are registered for short-time work. In addition, Continental is carrying out further measures to reduce costs and optimize working capital and to postpone investments” [7].

The list of examples in the automotive sector suffering substantial negative impacts is very long. Nissan has halted production at its Sunderland plant in the UK since March 16th 2020, where it manufactures its flagship EV, the Nissan Leaf. Sunderland is the largest car manufacturing facility in the UK, employing 7,000 workers. Nissan has announced its first loss in 11 years and attributes the fall in operating profits entirely to the Covid-19 crisis and disruption [8,9]. There are news reports that many UK suppliers of Nissan’s Sunderland plant are suffering delayed payments from Nissan [12].

The above examples shed light on how auto OEMs and Tier-1s are currently affected, how they are bracing for further demand shocks and production disruptions, and though forthcoming guidance is now suspended in almost all cases, an extrapolation of the sector’s outlook into a very challenging and precarious future is not impossible.

The first set of current common themes that are emerging across the automotive sector can be rather confidently listed as follows;

  • Shifting large components of labour cost as variable

  • Heavy reliance on relatively expensive short-term credit lines

  • Expectation of substantially-reduced current and near-term profitability

  • Adoption of broad-based cost-reduction and cash-conservation measures including halting dividends, reduction or elimination of share buyback programs and pay reductions

  • Negative expectations for near-term sector employment levels

  • Lowering of production outputs due to Covid-19 (current and near-term)

  • Increased production costs due to incremental health and safety measures

  • Very high uncertainty in automotive demand projections

These developments within the automotive manufacturing sector quite clearly spell out a highly uncertain near-term outlook. Factoring in dealership impacts, inventory effects, supply chain disruptions, consumer purchasing power erosion and change in consumer behaviour, could result in permanent sector-wide disruptions. Other macro-economic fallouts of the Covid-19 pandemic would additionally become clear only after sector players are once more able to provide the market with forward guidance, backed by meaningful forecasts as events unfold. 

One thing that is clear today is that due to the strategic importance of the automotive sector, governments around the world will have to step in with large industry bailouts, through sustained long-term financial support and considerable demand stimulating incentives to consumers. These measures may include very low or even zero-cost financing options in order to re-energise automobile demand back to 2019 levels once the Covid-19 crisis is eventually brought under control.

For companies developing self-driving technology intended for integration into automobiles as Advanced Driver Assistance features; specifically ‘Level 2+’ and ‘Level 3’, (with at least a $1,000 per unit item bill-of-materials), the timeline for adoption by auto manufacturers could inevitably be pushed out much longer than what was anticipated at the end of 2019. The automated driving technology sector outside traditional supply chains largely comprises start-ups that have been building; self-driving software, sensor technologies, mapping technologies, teleoperation systems, test tracks, and simulation facilities and AI-based perception components of various descriptions. Many of these highly innovative start-ups around the world may now be at risk of becoming Covid-19 collateral damage in context of the seismic shocks sustained by car manufacturers.

The existential question for the automated driving technology sector now is – whether auto manufacturers will moth-ball advanced automated driving technologies in the medium term or not, while they themselves recover from the deep and in some cases the permanent economic ravages of the Covid-19 pandemic. Early signs, such as Audi now announcing the shelving of their Level-3 Traffic Jam Pilot programme [13] and Ford postponing its autonomous vehicle service, do indicate that the automated driving technology sector must brace itself for a long and tough road ahead.