Auto Industry Outlook

By: Zacks Equity Research December 29, 2009

The auto industry is a highly concentrated one. About 10 global automakers account for over 77% of the production worldwide. Among them, Toyota Motors leads with a 13.3% market share, while its domestic rivals including Nissan and its alliance with Renault account for 8.4% of the auto market, Honda Motor 5.6% and Suzuki 3.8%. Among the Detroit automakers, General Motors (GM) holds 11.9% of the auto market, Ford 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 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 of China, India, Japan, Korea, Western Europe and the U.S.

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 is 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, including 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, 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.

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 historically weak demand and higher dependence on automakers. According to the Original Equipment Suppliers Association (OESA), 13 major U.S. direct auto market suppliers and 2 indirect auto industry suppliers have filed for Chapter 11 bankruptcy or have had their assets foreclosed on, while many others in the auto industry have simply liquidated in the first half of 2009. They include prominent components auto market suppliers such as Visteon and Lear , who cater to General Motors and Ford.

According to OESA, 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 who are unable to restart operations as automaker production resumes due to working capital shortfalls.

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, ArvinMeritor, Goodyear Tire and Rubber, Magna International, Superior Industries, Tenneco and TRW Automotive.

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.