Comment – European automotive: a slow-motion car crash

Demand for new cars grew in Europe by just 0.5 percent last year despite benign economic conditions. The recent downturn in manufacturing output in Europe has been largely driven by a dramatic slowdown in car production, which is only partially caused by the fall in demand from China. Chinese car sales fell by about 6 percent in 2018 and Goldman Sachs is predicting a bigger decline in 2019.

The Chinese car market is critical for all of Europe’s volume automotive manufacturers which have ruled the roost for so long, complacent behind huge barriers to entry to new players. These include Volkswagen (ETR:VOW), Daimler AG (ETR:DAI), BMW (ETR:BMW), Nissan (TYO:7251), General Motors (NYSE:GM), Ford (NYSE:F), Peugeot SA (EPA:UG) and Jaguar Land Rover (JLR, owned by Tata Motors (NYSE:TTM)).

JLR announced 4,800 job losses in early January, mostly in the UK where it employs about 40,000 people. This followed the announcement of a £354 million half-year loss. Some of its production is relocating to Slovakia with the help of a €130 million subsidy from Brussels. Ford, which employs 13,000 at its Bridgend and Dagenham engine plants in the UK, also announced a shakeup of its European business. Ford reported a $1 billion loss in Europe last year. Sales at Nissan’s UK business fell by £93 million last year to £6.3 billion and Nissan’s car production fell by 6.2 percent to 487,000 units.

European car makers are facing the challenge of tighter regulations limiting the use of diesel engines and the move away from the internal combustion engine towards electric-powered vehicles. The shadow over the future of diesel was lengthened by the emissions scandals afflicting both VW and Mercedes. While they are investing heavily in electrification, it is taking longer than expected for them to roll-out a full range of electric vehicles. In the meantime, Tesla (NASDAQ:TSLA) turned in excellent numbers for Q4 2018 thanks to strong sales of its Model 3. (The Model 3 does seem to have some reliability issues, however.)

Few doubt that electric vehicles are the industry’s future though it is still unclear whether lithium battery or hydrogen fuel cell technology will finally win out. According to the BNEF the number of electric vehicle models on the market will rise from 155 in 2017 to an estimated 289 in 2022, after which date it predicts that sales of internal combustion engine-powered vehicles will go into terminal decline ahead of being outlawed (in the UK and France) by 2040. (2030 in India.) Yet most established automotive leaders are still some way from offering a full range of electric-powered vehicles.

Production of cars in the UK was 129,030 in November last year – down by one fifth on November 2017. More than 80 percent of British cars are exported. About 1.7 million cars were manufactured in the UK with an estimated 60 percent of their components coming from abroad, making the industry uniquely sensitive to the outcome of the Brexit negotiations.

VW reported record sales in January, though some analysts fear that this may have come at the expense of profits as the company is thought to have discounted heavily. The company’s over-dependence on diesel has prompted a massive investment programme in electric and self-driving technology which is yet to bear fruit.

European automotive stocks slumped in December. The markets have assigned poor valuations to Germany’s three major car manufacturers while assigning optimistic valuations on more speculative stocks such as Tesla (despite the efforts of the short-sellers). All of the European volume manufacturers have huge fixed costs and enormous pension fund deficits. That is not likely to change.

Globally

The global automotive industry faces a systemic threat. Demand for new cars is falling as the economy slows; people are delaying new purchases in anticipation of electrification and driverless technology; and life-style factors cool demand thanks to the sharing economy. The traditional barriers to entry which have protected established volume producers are falling. A successful manufacturer of vacuum cleaners and hand dryers (Dyson – private) is currently building a factory which will produce electric cars in Singapore for the East Asian market.

The disruption of the global automotive market could not have come at a worse time for Germany and France. In both countries, car production accounts for a large proportion of total manufacturing.

And a slump in Germany, in turn, could have dramatic consequences for the future of the single currency. Brexit has restated the fundamental question of what the EU project is about. Is it a Europe of sovereign nation states trading amicably, or a federal European super-state led by Germany? Frau Merkel’s open-door immigration policies have led to the anti-immigrant Alternative für Deutschland (AfD) shooting up from zero votes in 2013 to the country’s third-largest political party in the September 2017 elections. Not to mention the open hostility of the Hungarians, the Poles and now the Italians.

The French automotive industry is particularly skewed towards diesel since diesel was actually favoured by tax incentives until about a decade ago. (Diesel fuel is still cheaper than petrol in France – the opposite is true in the UK.)

Meanwhile, France is distracted by a slow-burn revolution caused by an elitist globalist president who slashed taxes for billionaires but slammed new carbon taxes on semi-skilled tradespeople. Last Saturday, another 60,000 people rioted in most major French cities, confronted by 80,000 combat-clad policemen. French friends tell me that resentment about police conduct is now reaching boiling point. It is sad to see a country one loves in a state of such distemper.

Thus a protracted downturn in European manufacturing, with fewer cars produced, is likely to come at a moment of extreme economic and political uncertainty. The Chinese – who already buy over one million electric cars each year – will probably ride out the great disruption of the automotive sector with relative equanimity. I doubt if Europe will.

By Victor Hill, Macro Strategist at Master Investor