(TM) Auto Industry Outlook and Review – April 2010 – Industry Outlook

The auto industry is a highly concentrated one. About 10 global automakers account for over 77% of the production worldwide. Among them, Toyota Motors (TM) leads with a 13.3% market share, while its domestic rivals Incorporatedluding Nissan Motor and its alliance with Renault account for 8.4% of the auto market, Honda Motor (HMC) 5.6% and Suzuki 3.8%.

Among the Detroit automakers, General Motors (“GM”) holds 11.9% of the auto market, Ford (F) 7.8% and Chrysler-Fiat 6.4% of the auto industry.

The recent economic crisis has provided an impetus to a massive structural change in the auto industry, setting the stage for growth over the next decade. Given the high barriers to entry and the need for scale economies (in operations, supply chain and marketing), the global auto industry landscape is expected to be ruled by global automakers and suppliers based in the six major auto markets – China, India, Japan, Korea, Western Europe and the U.S.

In the key growth market of China, the domestic automakers are likely to be the most dominant ones as their government plans to consolidate the top 14 domestic automotive players into 10, with a more than 90% share in the local market.

OPPORTUNITIES

To remain competitive, automakers will need to design vehicles that will meet the requirements of consumers in both mature and emerging markets. Automakers will focus on more user-friendly and low-cost vehicles that are also the most advanced technologically.

The automakers will continue to shift their production facilities from high-cost regions such as North America and the European Union to lower-cost regions such as China, India and South America. For example, Greater China and South America together are projected to represent more than 50% of growth in global light vehicle production in the auto industry from 2008 to 2015.

There are two underlying factors behind this location shift in the auto industry. The first is the cost factor. The cost of labor in emerging auto markets continues to be a fraction of that in the developed world. The second is the demand factor. Many low-cost regions Incorporatedluding the emerging auto markets, have high potential for growth. Thus, the shift in auto industry production facilities will lead to a localization of the manufacturing base that will bring down transportation costs.

The emergence of trading blocs is also giving this process a push in the auto market. It is likely that over time there will be fewer car imports from outside a trade zone.

Further, automakers have started to reduce the number of technological platforms with a greater diversity of models produced from each platform in order to remain cost competitive in the auto industry.

For example, Honda, with its flexible common platform, has developed three dimensionally distinct versions of the Accord, allowing for designs where 60% of the components are common. Ford aims to build 680,000 vehicles per core global platform within five years, up from current levels of 345,000 units. After emerging from its bankruptcy, General Motors has started focusing solely on four core brands – Chevrolet, Cadillac, Buick and GMC.

Higher fuel prices and concerns over global warming have pooled attention on the auto industry that either rely less on traditional fossil fuels or use renewable sources of less expensive energy. Thus, “green” alternatives such as fuel-efficient electric vehicles (EVs) and hybrids will attract consumers in the wealthier countries while flex-fuels such as ethanol and natural gas will be highly sought-after in the emerging auto markets where the local climate or resource base favors their usage by automakers over petroleum.

Consequently, there will be a variety of powertrain technologies in the auto industry by the next decade. It is likely that “green” cars will represent up to a third of total global sales in developed auto markets and up to 20% in urban areas of emerging auto markets by 2020. Some of the “green” cars have already generated a huge response in the auto industry. These include the Ford Focus, GM Volt, Daimler (DAI) Smart, Nissan Leaf and Toyota Prius.

The role of governments must not be overlooked. Governments in all major countries have become active auto industry players. Their investments through emergency loans and incentive packages, such as “Cash for Clunkers” in the U.S., are a good example of this. Moreover, governments’ energy and environmental policies will be highly responsible in molding the auto industry in the coming years.

Detroit’s Comeback

The Big Three Detroit automakers — GM, Ford and Chrysler — lost consumer confidence in 2009 after they were severely hit by the global economic crisis. The crisis also exposed the inherent problem with the Big Three’s product portfolio, which lacked up-to-date engineering and extensive research and development.

Further, the majority of their sales comprised pickup trucks and SUVs rather than fuel-efficient vehicles such as the small cars that the consumers have started to prefer. In 2009, GM’s truck sales accounted for 54% of the cars and trucks sales, Ford’s 62% and Chrysler’s 73%.

This skewed portfolio was further aggravated by the government’s push for fuel-efficient and environment-friendly small cars. Ford rallied better than its hometown rivals, with an early response to the shift in consumer preference towards small cars. In 2009, sales at Ford dropped 15% while sales at GM and Chrysler plunged 30% and 36%, respectively.

However, with a recovery in the global market and restructuring of the product portfolio, the Detroit automakers — especially Ford and GM — stood up at the end of 2009. Ford focused on its Ford, Lincoln and Mercury branded cars, shedding Volvo cars, while GM concentrated on four core brands — Chevrolet, Buick, GMC and Cadillac — withdrawing Saturn, Hummer, Pontiac and Saab.

In December last year, Ford saw its best month since May 2008 by posting a sales gain of 33%, driven by a wide acceptance of its redesigned Taurus, Fusion and Escape. Meanwhile, sales of GM’s four core brands grew 2% during the month. In the first quarter of 2010, Ford’s sales surged 39.5% while GM’s sales rose 17.4%. The recent fall from grace of Toyota due to its massive recall (touched upon below) has been a major boost to the Big Three’s fortunes, as well.

WEAKNESSES

Although automakers continue to focus on shifting their production facilities to new regions driven by cost and demand factors, developing the supplier networks remains one of the greatest challenges they face in the auto industry. Existing suppliers to automakers often lack the financial background to expand capacity in new markets. On the other hand, auto market suppliers are sensitive to technology transfers to local third parties, which may result in new and lower-cost competitors.

The financial condition of the majority of auto market suppliers continues to deteriorate, resulting from a historically weak demand and higher dependence on automakers. According to the Original Equipment Suppliers Association, 12% of the auto industry suppliers do not have sufficient working capital to support a 10%–25% expansion in production.

Thus, despite the government’s sizable investment in the automakers, it is likely that there will be auto market suppliers unable to restart operations due to working capital shortfalls even as automaker production resumes.

Higher dependence on automakers makes the auto market suppliers vulnerable to several maladies, primarily pricing pressure and production cuts. Pricing pressure from automakers is constricting auto market suppliers’ margins. On the other hand, production cuts by automakers driven by frequent market adjustments are negatively affecting their operations.

Some of the auto industry suppliers who have a high reliance on a few automakers such as General Motors, Ford, Chrysler and Volkswagen include American Axle and Manufacturing (AXL), ArvinMeritor (ARM), Goodyear Tire and Rubber (GT), Magna International (MGA), Superior Industries (SUP), Tenneco (TEN) and TRW Automotive (TRW).

The shift in auto market consumer preferences towards hi-tech, fuel-efficient, environment-friendly vehicles, such as small cars/hybrids/EVs, is another issue. Auto market suppliers are expected to quickly adapt to the new technologies by investing in research and development, putting heavy capital burdens on them.

The automakers also face significant challenges in transforming the existing powertrain technologies into the new versions, as far as marketability is concerned. As the number of technology applications increases, automakers and suppliers will need to be selective. Their criteria for choosing what to include and what not to will depend entirely on what the customers are willing to pay for.

Recall – The New Auto Crisis

Vehicle recalls have become the talk of the town after Toyota’s announcement of the largest-ever global recall of 8.5 million vehicles related to problems such as faulty accelerator gas pedals and slipping floor mats as well as faulty braking systems. The recall included popular models such as 2010 Prius hybrid and Toyota Camry.

The recalls hurt the reputation of the automaker so much that it had to suspend the sale of 8 models in January 2010 and halt new car launches for the full year.

In the spate of recalls following Toyota’s, other automakers started bringing back vehicles from the market. Nissan found faulty brake pedal pins and fuel-gauge component problems. Honda discovered flaws in air bag inflators and braking systems and General Motors admitted to defects in steering wheels, fuel hoses and seating problems in certain models.

In order to break free from the backlash of safety recalls, Toyota began offering huge promotions Incorporatedluding cheap leases, zero-percent financing for 5 years and free maintenance for 2 years for return customers on most of its line-up. According to Autodata Corp., Toyota’s incentive during March 2010 increased 46% to $2,310 per vehicle compared with GM’s incentive of $3,174 per vehicle (down 19% year-over-year) and Ford’s incentive of $3,035 per vehicle (down 2% year-over-year).

However Incorporatedentives are mixed blessings. A dismal situation arrives once they inevitably expire and demand slumps back to the traditional level. Dealers run out of stock for popular models, compounded by a slow ramp-up of production by the automakers to replenish the lots. On the other hand, if the incentives are extended further, as announced by some automakers including Toyota, it exerts a lot of pressure on the respective automaker’s inventory and profit margins.Zacks Investment Research

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