Global Autos: The Bumpy Road Ahead - Part 1

July 12, 2019

Cars For Sale, Automotive Industry, Cars Dealership Parking Lot. Rows of Brand New Vehicles Awaiting New Owners, on the epoxy floor in new car service


Slowing global economic growth combined with trade tensions are starting to pressure automaker profitability.
Eric Espeseth, Senior Credit Analyst

As global economic growth begins to slow, the automotive industry is facing several headwinds including slowing sales growth in key markets, uncertainty surrounding trade and tariffs, increasing regulatory requirements and a shift toward electrification and autonomous driving. Combined, these factors will drive expenses higher and profit margins lower.

Sales of new cars in the U.S. have posted year-over-year declines each month thus far in 2019. This trend is expected to continue, with S&P Global Ratings (S&P) forecasting a 3.6% decline for U.S. new car sales in 2019. While absolute sales volumes remain near cycle highs, sales are being negatively impacted by rising vehicle prices and higher interest rates.

Chinese auto sales have also softened due to slowing economic growth along with pricing pressures and increased competition. Last year, China's economy grew at its slowest pace in 28 years and GDP growth slowed further during the first quarter of 2019. Vehicle demand has been impacted by slower growth and S&P forecasts sales will decline 3% for 2019.

A significant factor driving the increase in vehicle prices and weakening consumer demand has been the impact from changing trade policy and tariffs - both directly and indirectly. As part of the ongoing U.S. / China trade war, tariffs have been imposed directly on automotive vehicles and parts. China raised tariffs on U.S.-built vehicles by 25% in July 2018 (to 40%) and the U.S. followed by imposing a 10% tariff on auto parts imported from China (since increased to 25% in May 2019). China temporarily suspended the 25% increase in December 2018 and a further increase in tariffs is currently on hold as the two countries continue to negotiate a potential trade deal.

The shift in trade policy has also brought into question the future of existing trade deals - including the recently revised USMCA trade agreement - and raised fear of tariffs being placed on automotive imports from Europe and Japan. The trade war, and risk of additional tariffs, has introduced a significant amount of uncertainty for both consumers and manufacturers.

To limit the impact on profitability from weakening demand, auto manufacturers are working to lower production volumes and dealer inventories. But to reduce inventory levels, manufacturers have been increasing incentives on new vehicles. This increase will negatively impact profit margins in the present but reduced production volumes will have a positive through-cycle impact on manufacturers.

Given near-term pressures on automotive profitability, we have a cautious view on the sector. The need for fundamental issuer selection in this environment is critical and we favor manufacturers with broad product and geographic diversification, strong balance sheets and significant liquidity. We continue to view prime auto ABS securities positively as these instruments rely on consumer loan repayment and our outlook for the U.S. consumer remains solid.

While overall auto demand is forecast to slow, we do not expect a significant decline in annual vehicle sales as U.S. consumers are being aided by favorable economic conditions including historically low unemployment, elevated consumer confidence and modest wage growth.

Challenges posed by increasing regulatory requirements and shifts toward electrification and autonomous driving will continue to impact manufacturer profitability over the coming years. We will explore these challenges in a future blog post.



CNN, China is Temporarily Slashing Tariffs on US Auto Imports, December 14, 2018

Nikkei Asian Review, China's GDP Growth Slows to 28-year Low in 2018, January 21, 2019

Reuters, China Will Continue to Suspend Extra Tariffs on US Vehicles, Auto Parts, March 31, 2019

S&P Global Ratings, Japan Credit Spotlight: Automobiles and Components, July 3, 2019

Wall Street Journal, U.S. Auto Sales Slipped in First Half of 2019 as Prices Climbed, July 2, 2019

Wards Auto, U.S. Raises Duties on Chinese Auto-Parts Imports, May 10, 2019