There has been at least one positive from the pandemic: It has forced automakers to increase their financial discipline. Being more conscious about working capital has boosted the operating margin at many vehicle manufactures, said Bank of America’s head of European automotive research, Horst Schneider. He discussed this and explained why he doesn’t expect plug-in hybrids to survive in the long term during an interview with Automotive News Europe Correspondent Christiaan Hetzner.
What long term effects on the auto industry do you see resulting from pandemic?
When it comes to the manufacturers there is a much greater focus on financial discipline. When Daimler first forecast in November 2019 an operating margin of more than 6 percent at Mercedes’ cars and vans business by 2022, the consensus was that they wouldn’t make it. Now it appears conservative because the company has fundamentally changed its approach with a 20 percent cut to capex [capital expenditure] and fixed costs in the coming five years. They are taking a Peugeot approach, preferring to be a fast follower to concentrate more on brand value. Companies are also more conscious about working capital, for example, in the channel mix. Dealers deliberately hold less stock. We have found cases where there are 30 percent fewer cars on their lots, since retailers are careful with their inventory management.
How have the customers’ needs changed?
You also see a change in behavior. Emerging markets such as Turkey should be seeing much lower car demand given the plunge in the lira, but sales are up nearly 80 percent through October. In Europe it’s hard to get a used car for below 3,000 euros – the lots are empty because of the demand for cheap mobility. It’s an indication people are reluctant to use public transport.
At the start of the year, CO2 compliance was the big issue. Automakers had a year to reduce their fleet emissions by more than 20 grams per kilometer, more than what they achieved in the previous decade combined. Are automakers going to achieve their CO2 target of 95 g/km in 2021?
That is what the automakers say. Many only accelerated their plug-in hybrid and full-electric cars rollouts in the second half of this year, which is when the subsidies in Germany were increased. Therefore, the automakers will have the benefit of a low comparison base in the first half of next year. I estimate a more than 50 percent increase in volumes of electrified vehicles should be easy to achieve. With the generous incentives currently in place, I don’t think compliance will be much of an issue next year. For example, Volkswagen Group confirmed this month that it would meet the target in 2021 with its new products [after failing to do so in 2020]. However, difficulties meeting the CO2 target could return when the EU rules tighten in 2025 and 2030.
The EU has talked about asking automakers to further cut fleet CO2 emissions by 50 percent, up from a 37.5 percent reduction passed into legislation in 2019. Is the high cut too ambitious or could full-electric cars be standard in many parts of the EU by then?
It’s still too early to forecast that far ahead. At the moment, I’m skeptical about the business case for cars like the ID4 [VW brand’s first full-electric crossover]. Yes, it’s an expensive segment where you can price models higher. Theoretically, it’s also easier to make a profit on crossovers. But if you look at it from customer’s perspective, it seems to be a hard sell. The ID4 would replace the Tiguan in a single-car household, and there are still a lot of people who want their cars to be able to drive from Frankfurt to Lake Garda in Italy without refueling. A cheaper EV may suffer from a perceived limited range, but if it serves mainly as the second car for the daily commute it suddenly makes more sense, especially once you factor in the hefty subsidies.
What about models such as the Mercedes GLE 350 plug-in hybrid, which has a certified CO2 rating as low as 33 g/km under NEDC rules? That figure is below the potential fleet target for 2030.
In the future I expect regulators will legislate away the generally beneficial treatment of plug-in hybrids, mandating a minimum range of possibily 100 km. This will make them less attractive from a cost perspective versus full-electric vehicles. Don’t forget the Green Party in Germany will almost certainly form part of the government following the September general election and they will likely take a more drastic view toward emissions legislation. Therefore, I don’t see plug-in hybrids surviving in the long term. The question is how soon will we see cheaper, more powerful batteries capable of very long ranges. If you believe the claims of some solid state cell developers, they may be only a few years away.
Should we expect better margins for full-electric vehicles given their more simplistic mechanical structures?
In theory, automakers can make good money on full-electric cars if their battery costs come down. They also no longer need to invest every year in technology that lowers the various emissions vehicles with combustion engines product. The main problem is the costs that come with winding down your legacy business. Once that task is done then capex can be structurally lower and margins higher. But this is only one aspect. If EV startups gain market share and become as large or larger than existing automakers, which is what their current market valuations would suggest, then they will have to take that from someone. [Tesla CEO Elon] Musk says he wants to sell 20 million vehicles a year, for example. So, the question then is which legacy automaker loses business in this scenario.
We saw with the dotcom bubble that financial markets are poor allocators of capital during periods of transformational change. Investors are further incentivized to pile into growth stocks such as Tesla due to ultra-low or even negative yields on sovereign debt. Could this switch once a COVID-19 vaccine is readily available and central banks no longer need to keep their foot on the accelerator?
If yields increase next year, which is what Bank of America currently predicts, then you could very well see a rotation back into underperforming value stocks in European automakers. As long as the cost of money remains so cheap, investors will be attracted to the riskiest assets, but it’s not just startups that benefit. Renault or PSA/Fiat Chrysler are outperforming. Importantly this is a general trend that is not specific to autos.
