Which carmakers will survive Automotive Armageddon?

The automotive sector is in distress. But where there is disruption, there will be successful disruptors who will win out. Victor Hill investigates.

The global automotive sector is facing unprecedented disruption. It is still one of the world’s greatest industries, with 87 million unit sales per year. But car ownership is going out of fashion – at least with the young who are disciples of the sharing economy and summon rides through their smartphones. Diesel is a synonym for toxic. The day of the gas guzzler is clearly dead with Britain and other advanced countries now committed to going carbon neutral by 2050 (just 21 years away). Self-driving electric cars are just around the corner (or so we are constantly told) – but what will they look like and who will buy them?

In short, one of the world’s largest manufacturing industries of the last 125 years faces both changes in demand and massive changes in technology at the same time. This has led to falling output (not helped by a slowdown by global growth); falling margins; and, sluggish share prices for the 20 or so top volume automotive manufacturers worldwide.

The response of the industry has been threefold. First, a number of big names have announced plant closures as they cut back production. Second, there is a wave of consolidation underway as volume players seek increased economies of scale. Third, the market leaders are stepping up the transition to electric vehicles (though not fast enough).

For investors, this is a distressed sector with apparently not much upside in the near-term future. But where there is disruption, there will be successful disruptors who will win out. How can investors sniff out the medium-term winners?

The eternal defensive strategy: merge and consolidate

Before he died last year, the chief executive of Fiat Chrysler, Sergio Marchionne, warned that excessive competition was killing the global automotive industry. He proposed that manufacturers needed to join forces. Carmakers are having to invest huge sums in R&D as emissions controls and tighter regulations bite. He argued that almost half the cost of developing a new model was accounted for by the development of products and technologies of which the purchaser is not even aware, such as engine components and in-car software.

Signor Marchionne identified two possible solutions. First, carmakers could reduce their product range; second they could join forces to share R&D costs and generate greater economies of scale. Carmakers need an output of about 10 million cars a year now to break even – and only Toyota (TYO:7203), Volkswagen (RTE:VOW) and Renault-Nissan are at that level. He reckoned that the global automotive industry was spending $2 billion a week on R&D – and that most of this was duplicated.

It now seems that Signor Marchionne’s call for the industry to consolidate has been heard. A wave of alliances, cross-holdings, joint ventures, partnerships, mergers and buy-ins is now sweeping the sector.


VW and Ford (NYSE:F) had already announced plans to team up in the US to produce vans. In July they announced a bolder collaboration. Ford will use VW’s modular electric toolkit (MET) to develop at least one new electric model. The MET is a kind of chassis with a battery onto which a car body and interior can be placed. VW has spent billions on developing the MET (sometimes irreverently called a skateboard) and now plans to recoup some of those costs by selling the technology to other carmakers. In this way the automotive industry is becoming like the smartphone industry: a basically similar chip and operating system supports numerous designs with different functionality.

Jaguar Land Rover(JLR, owned by India’s Tata Motors (BOM:500570)) and Peugeot SA (ETA:UG), which is owned 13.7 percent by the French state, are also thought to have had talks about a possible tie-up. Against this backdrop, in late May, it was revealed that Fiat Chrysler (NYSE:FCAU) had proposed a merger with French carmaker Renault (EPA:RNO) in a deal worth $33 billion to create the world’s third-largest automotive giant behind VW and Toyota. By the terms of the proposal, each party would own 50 percent of the new entity which would have combined unit sales of 8.7 million vehicles a year and revenues of nearly $170 billion. Renault announced that it would study Fiat’s “friendly proposal” with interest.

The logic of the deal was that Renault could shore up Fiat’s loss-making European business while Fiat could offer Renault a foothold in the North American market where it has some strong brands such as Jeep. Between the two, Renault has the edge in terms of electrification – but, together, the two giants could achieve huge economies of scale in manufacturing electric cars. The timing of the proposal came as a parting of the ways between Renault and Nissan (TYO:7201) seemed quite likely.

Initially, all the governments involved – France, Italy, America and Japan – appeared to be on-side and there seemed to be few regulatory issues to resolve. But within two weeks the proposed deal collapsed. Fiat Chrysler withdrew its offer, claiming that the French government (which has a controlling stake in Renault) had required the support of Nissan. The real issue was that the French government wanted guarantees that there would be no job cuts in France. More bluntly, Fiat said in a press statement that “political conditions do not currently exist in France to carry out such an arrangement”. The Agnelli family still has a 29 percent stake in Fiat-Chrysler.

Chinese carmakers have also asserted themselves. Geely (HKG:0175), run by billionaire Li Shufu, bought Volvo from Ford for $1.8 billion in 2010. (That was just a quarter of Volvo’s value when Ford took it over a decade earlier for $6.5 billion). Since Geely took control, Volvo’s output has almost doubled. It has even launched a luxury electric brand, Polestar. Geely has also acquired LEVC (which makes, amongst other models, London’s black cabs), and Lotus (for $1.5 billion).

Geely also has a 9.7 percent stake in Daimler AG (ETR:DAI)which it bought for $9 billion. Chinese automotive giant BAIC (HKG:1958) has a five percent stake in Daimler. This gives both players huge intellectual capital in terms of how to design, style and build state-of-the-art motor cars.

Not all marriages in the automotive sector are happy ones. Chrysler partnered with Daimler in 1998 but that arrangement came to an end in 2007 on account of fundamentally different corporate cultures. The Nissan-Renault tie-up also may be coming to an end partly, but not only, due to Japanese resentment at the French partner’s dominance. Reportedly, the Fiat-Chrysler tie-up is also under strain.

Some of the most radical innovation in an industry sometimes occurs when a market stagnates. 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 (the German economy contracted by 0.1 percent in Q2) has been largely driven by a dramatic slowdown in car production, which is only partially caused by the fall in demand from China. Chinese passenger car sales fell by 6.7 percent in 2018 to 22.7 million units (out of 87 million globally) and Goldman Sachs is predicting an even bigger decline for 2019.

The Chinese car market – comprising over one quarter of the global market − is critical for all of Europe’s volume automotive manufacturers which have ruled the roost for so long, secure behind huge barriers to entry.

Electrification accelerates

One of Theresa May’s last acts as prime minister was to commit the UK to becoming carbon neutral by 2050. This means in practice that CO2 emissions should be brought down to a level that could be entirely offset by carbon capture and storage (CCS) technology. Cars are currently one of the major causes of CO2 emissions thanks to the fossil-fuel-powered internal combustion engine (ICE). The UK government had already set a target of 2040 after which date no further ICE-powered vehicles will be sold: by then all vehicles on the road will be electric. France has also set a 2040 target for electrification – though India has been even more ambitious with a target of 2030 (whether that is achievable is another matter).

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 Bloomberg NEF, 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. Yet most established automotive leaders are still some way from offering a full range of electric-powered vehicles.

The key drivers of increasing ownership of electric cars are threefold. First, the range of electric vehicles must be far enough to make middle-distance journeys viable without a recharge. Second, there must be a sufficient network of widely and easily available charge points. Thirdly, electric cars should not be appreciably more expensive than their CO2 spouting equivalents.


Well, the range of electric cars is lengthening fast with improved battery technology. The number of charge points in the UK is increasing exponentially. Tesla (NASDAQ:TSLA) has pioneered a network of free-to-use charging points. And, according to Deloitte, the cost of owning an electric car could be equivalent to owning a petrol or diesel car within two years.

Battery-powered electric cars will be cheaper to run than petrol or diesel-powered cars. Not only will the charging costs be less than the equivalent cost of fuel, but they will require less maintenance and fewer spare parts than conventional cars. That is because they are mechanically simpler – there is less that can go wrong. That is good news for drivers, but it means that the lucrative after-market in spares and repairs will dry up. That is bad news for businesses like Unipart.

Electric cars are still more expensive than their petrol or diesel-powered equivalents. The Model S costs around £75,000 to buy new in the UK – around the same price point as Range Rover Evoque. But the all-electric Hyundai Ioniq comes in at just £20,000.

There is already a move away from hybrid cars towards battery-powered cars. This is partly a function of the subsidy regime. In October last year the UK government scrapped the £2,500 grant available for plug-in hybrids while lowering the maximum available for battery-powered cars from £4,500 to £3,500.

Recently Ford invested $500 million in electric car start-up Rivian, a maker of electric ‘adventure vehicles’. This followed Apple’s investment of $700 million in Rivian earlier this year.

Powering up

Electrification is great news for power generators and distributors. Using the Octopus Energy’s Go EV tariff, drivers of electric cars pay a reduced rate of 5 pence per kilowatt hour if they charge overnight. That means that a full charge of a Tesla Model S costs around £4. Ovo EV offers the ‘Everywhere’bundle which includes a free home charger or membership of one of the main charging networks. Users can even sell unused electricity back to the grid. EDF’s (EPA:EDF) GoElectrictariff offers cheaper tariffs between 9pm and 7am. E.ON’s (ETR:EOAN) Fix & Drive tariff comes with a £500 grant for a home charger.

Other electricity suppliers offering tailored packages for electric-car drivers include Scottish and Southern Energy (LON:SSE), Bulb Energy and Shell Energy. All these electricity suppliers are committed to making the transition to electric vehicles easier. At a Downing Street summit in May it was proposed that every new home in the UK should be required to have a charging point for electric cars. That is likely to be enacted in law shortly.

Meanwhile, the power outages across parts of England on 9 August have raised the question of whether National Grid (LON:NG) has the power-generating capacity at its disposal to charge millions of new electric cars. (Incredibly, two power plants were taken out by one lightning strike!). According to one study, electric cars could double peak demand from current levels in 10 years’ time. A huge investment may have to be made in new generating capacity that is used only part of the time.

Tesla fights back

Tesla (NASDAQ:TSLA) turned in excellent earnings numbers for Q4 2018 thanks to strong sales of its Model 3, its first mass-market car. (The Model 3 does seem to have some reliability issues, but in July Tesla cut the price of the Model 3 in the UK to £37,340 (including VAT and the plug-in car grant)). Yet the Q1 2019 results were awful – the company lost $702, partly on account of delays in deliveries. On the plus side, Tesla has managed to slash costs over the last 12 months, closing many of its showrooms and reducing its workforce by 16 percent.

Reports started to circulate in  late spring that Tesla was facing a cash crunch, given a $10 billion debt pile with $566 of repayments due in November. Most analysts think the company will have to raise new capital in the order of $2.5 billion – despite Mr Musk’s earlier protestations that that would not be necessary. The yield on Tesla’s 2025 bonds stands at around the 8.0 percent mark at time of writing (it has a 5.3 percent coupon).


Founder and CEO Elon Musk has declared that Tesla “is light years ahead of everyone else” in the field of self-driving cars because it has accumulated more data from its autopilot function equipped on all its models. Tesla fans in Europe have called on the EU to repeal restrictive rules on the use of the system. In April Mr Musk said that his company would have one million self-driving cars on the road in 2020.

Tesla’s shares at time of writing in late August are trading at $226 – well up from a low point of $179 on 31 May. Some analysts regard Mr Musk’s attitude to corporate governance as a drag on the share price; fund manager Baillie Gifford, which has a 7.5 percent stake in Tesla worth $3 billion, suggested this month that Mr Musk was “not irreplaceable as chief executive”.

Diesel: the end

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 Daimler AG (which manufactures under the Mercedes brand). In 2015 the VW Group admitted that it had equipped up to 11 million vehicles worldwide with devices that allowed them to cheat emissions-control tests. While both those firms are investing heavily in electrification, it is taking longer for them to roll out a full range of electric vehicles than expected.

Daimler announced in late June that it is expecting further liabilities in connection with its complicity in faking diesel emissions from its vehicles one day after the German government ordered the recall of 600,000 diesel-powered Mercedes cars.

Since April this year, the latest diesel cars in London’s Ultra Low Emissions Zone (ULEZ), which covers central London) are subject to a charge of £12.50 per day – and older ones are banned altogether. From 25 October 2021, the ULEZ will be expanded to include the inner London area bounded by the North and South Circular Roads (that is most of Greater London).

Stock-market performance

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 in the near future.

If uncertainty around Brexit is inhibiting new investment in the automotive sector in the UK, something similar is unfolding in America. The United States-Mexico-Canada (USMCA) agreement to update NAFTA was signed off on 30 November last year but has not yet been ratified. American unions are lukewarm about the deal and the new Democrat-controlled House of Representatives has concerns about the enforcement of workers’ rights in Mexico.

European car producers with production facilities in the US are better placed to ride out President Trump’s threat of higher tariffs on imported cars. At the Detroit Auto Show in January, VW announced plans to upgrade its plant in Chattanooga, Tennessee, where it will build its first electric-vehicle facility in the US. The $800 million investment is expected to create another 1,000 jobs. The first electric vehicle is expected to roll off the Chattanooga production line in 2022.

Driverless cars

The other aspect of the automotive revolution – the advent of driverless cars – requires that they invest in a whole range of related technologies, of which artificial intelligence (AI) is just one.

What is holding back the arrival of driverless cars is the issue of safety. Last year a pedestrian was killed by a driverless Uber taxi in Arizona. Uber has even constructed a fake city where it is testing driverless vehicles using dummies and robots rather than human pedestrians.

Interestingly, one of the most difficult manoeuvres to robotise is the left turn (in right-hand drive countries)/right turn (in left-hand drive countries) when the vehicle must turn into the flow of oncoming traffic. Robots, it seems, are either too timid to find a gap at all or are daredevils who cause collisions. Another problem is teaching machines how to read human behaviour. Someone reading a newspaper at a bus stop is much less likely to step into the road that a pedestrian looking right and left. But getting the machine to understand that simple thing requires a very high level of AI.


The organisation set up by the UK Department of Transport (DOT) to help develop driverless cars is called Zenic. Addison Lee (a privately owned courier company) and Oxbotica (a privately owned software company) have been trialling self-driving vehicles on British roads under licence from the DOT in the London Borough of Greenwich.

Chinese tech giant Huawei(nominally owned by its employees) says it will launch self-driving cars as early as 2021 in collaboration with Audi (part of the VW Group), Toyota and others. JLR has signed a contract to supply 20,000 I-Pace electric Jaguars to Waymo’s operation in Detroit where they will be used to test the Google subsidiary’s self-driving technology. Similarly, Volvo is supplying Uber with vehicles that are destined to become self-driving taxis. Ford has also invested $1 billion into the autonomous vehicle specialist Argo AI. Meanwhile, BMW (ETR:BMW) is working with China’s Tencent (HKG:0700) and Baidu (NASDAQ:BIDU) on driverless cars.

That all sounds very exciting but no one seems to know when we shall be able to purchase a self-driving vehicle and command it to take us home. Tech titans like Apple (NASDAQ:AAPL) and Alphabet/Google (NASDAQ:GOOGL) (in the form of its subsidiary Waymo) are software companies and will never manufacture cars. The volume automotive players still don’t know whether there will ever be significant popular demand for driverless cars. The initial market at least will be with the ride-hailing apps and other champions of the sharing economy.

Changes in consumer behaviour

Millennials seem to be less inclined to buy cars than their parents. Car ownership by under-35s in the US is plummeting. Fewer British millennials are even bothering to pass their driving test. That may be partly a function of lifestyle: they generally live in cities with good public transport and they are also more conscious of the environmental impact of motoring. Cars do not seem to be such a status symbol amongst the young.

Anecdotally, many consumers have decided to postpone the replacement of their petrol-powered cars because they anticipate that in two-three years the price of electric cars will have come down substantially. This is a classic example of deferred purchase – which implies falling demand. We shall probably come under increasing social pressure to go electric as time goes by. People who still drive gas-guzzlers will be regarded as antisocial long before 2040.

Because cars are generally better engineered these days (thanks to better design and production technology) most decent cars will be perfectly serviceable for 10 years or more. My hunch is that people will tend to change their car less often as time goes by. What is clear is that car ownership – electric-powered and self-driving, or not – is likely to decline in coming years. That suggests that there is overcapacity in the global automotive industry.

The rise of the sharing economy means that many people, not least in the US, are hiring cars as and when they need one rather than buying one outright. Uber (NASDAQ:UBER) and Lyft (NASDAQ:LYFT) are now ubiquitous. Significantly, Toyota recently invested a reported $500 million in Uber and GM invested an equivalent figure in Lyft. Presumably, they see these ride-hailing apps as hugely important future purchasers of their products.

Car-rental companies are doing reasonably well – a sector dominated by the “big three”, that is Hertz, Avis (NASDAQ:CAR) and Europcar (EPA:EUCAR). But even they are under threat from the rise of peer-to-peer car-hire apps such as Turo. Turo is a San Francisco-based unicorn which enables car owners to generate revenues from their cars by renting them out on a daily basis to people in need of transport. In 2017, according to Turo, four million users had registered to use the service and 170,000 privately owned cars were available for rental in 5,500 locations across the USA, Canada, the UK and Germany. The service is especially popular with tourists but users need to be pre-approved before they can summon a hire car.

Luxury car brands: Ferrari versus Aston Martin

One bright spot in a declining market might be niche luxury automobile brands. But it is a mixed picture.

Italy’s Ferrari (BIT:RACE) has an unrivalled brand image and is in the process of increasing production. Last year it produced 8,500 units but in the first six months of this year it delivered 5,281 cars. Germany’s Porsche (ETR:PAH), in contrast, produces 250,000 units in six classes. Ferrari will never rival Porsche in production volume but there is huge potential to scale its operation.

In early August Ferrari reported 2019 H1 revenues of €1.9 billion, up 11 percent on the previous year. Net profit for the half year was €36 million, a rise of 18 percent. This robust performance was driven by keen sales of the Portofino – an entry-level grand tourer. The average selling price of a Ferrari car was €287,000.

Ferrari was spun off from FIAT (Fiat Chrysler (BIT:FCA)) in January 2016 but the brand goes back to 1940. Ferrari can command high margins and is profitable. Miton European Opportunities Fund regards it as a long-term holding.


Why then has the Warwickshire, UK-based Aston Martin Lagonda (LON:AML) – another iconic luxury brand – fared so badly of late? Its shares plunged by another 12 percent in late July after the sports car-maker posted a £78.8 million loss, blaming a “worsening trading environment” and “continued macroeconomic uncertainty”. The company revealed that the selling price of its cars had fallen from £167,000 last year to £145,000. The company slashed its sales forecast for this year by 1,000 units – it is likely to manufacture only 6,300 cars this year. Its target is to raise that to 14,000. But is that realistic?

The brand has its keen adherents but has been unable to achieve sufficient economies of scale. Since the firm’s IPO in October 2018 at nearly £19 per share (much derided by some analysts) the share price has fallen to £4.45 at time of writing – a disastrous investment for those who have held the shares. Aston’s chief executive, Andy Palmer, has been criticised by commentators. Analysts at Canaccord believe that the company will have to raise new capital given its 700 million in debt pile. Leading shareholders include a number of Kuwaiti funds and the Italian private equity firm Investindustrial.

The key point about luxury brands is that they are price insensitive (their purchasers gain status from the fact that they are expensive). Also, they tend to be less sensitive to an economic slowdown (the rich, unlike the rest, continue to spend). That is all very well. But unless they pursue electrification they will just become collectors’ items for use at private race tracks. Though, at this rate, Aston Martin is likely to disappear well before 2040.

Action

The global automotive industry faces systemic disruption. Demand for new cars is falling as the global economy slows down; people are delaying new purchases in anticipation of electrification and driverless technology; and lifestyle factors cool demand thanks to the sharing economy. The traditional barriers to entry which have protected established volume producers are falling. Evidence for this is that 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 significant proportion of total manufacturing. (Car production accounts for four percent of German GDP but just 0.8 percent of UK GDP). The French automotive industry has been particularly skewed towards diesel since diesel was actually favoured by the tax regime until recently. (Diesel is still cheaper than petrol in France – while the opposite is true in the UK).

In order to profit from the great automotive Armageddon, investors need to cast their nets wider towards the players who will offer a full range of electric vehicles soon – and their principal suppliers. There are a few guidelines we can apply.

First, sales of battery-powered cars are rising rapidly while those of hybrid engines are already in decline. This is partly due to a change in subsidy regimes. Volume manufacturers that have hedged their bets with hybrid engine models have missed the boat. Investors should favour car producers that have invested in battery technology and battery production. One such is Tesla, which, despite the shortcomings of its management, has consistently blazed a trail in technology and design. Tesla’s full potential has still to be unlocked.

Second, volume carmakers which are already supplying the sharing economy are likely to establish a competitive advantage. JLR’s deal with Waymo and Volvo’s deal with Uber are significant. It’s worth noting that JLR’s parent company, Tata Motors, is well placed to supply India’s leading hail-and-ride operation, Ola, which is growing rapidly.

Thirdly, volume car producers which have a lead in electrification technology, and who are able to supply such technology to their peers will build up a competitive advantage as they begin to set industry standards. Volkswagen stands out with its MET – even though I am not sanguine about Germany in general right now and VW’s involvement in the emissions scandal will continue to generate liabilities.

The short-term outlook for the automotive sector is poor − though there could be buying opportunities as share prices are bid down excessively. In the medium term, we should expect more consolidation in the sector as the tipping point nears where sales of electric vehicles surpass those of petrol and diesel-powered cars. That moment could be much closer that we think – perhaps as soon as 2025. Investors will have to keep their eye on this ball.