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Covid-19 and the Auto Industry – the way forward

Covidautos

Equity market indices continued to gain ground, boosted by the gains across cyclical sectors. In European equity markets, the financials, industrials and consumer discretionary sectors took the lead over the past month. From an industry perspective, the automotive industry managed to outperform within its sector, recording double digit gains over the past four weeks. The significant rebound has lifted automakers from depressed share prices. Even so, industry returns in Europe still stand 18% below beginning of the year prices.

The covid-19 pandemic has added further pressures to automakers, which were already challenged by two industry headwinds: the shift to electrification and the CO2 emissions targets. The temporary halt of production lines disrupted the supply process while the closure of showrooms and dealers negatively impacted overall sales. As a result, the covid-19 pandemic and the consequent lockdowns significantly impacted financial results for the first quarter of the year.

The sales decline recorded across automakers mirrors the pandemic hit across the whole automotive industry in Europe. In April, vehicle sales in Europe, plunged by 77% in comparison to the prior year. Furthermore, new car registrations in Germany declined by 61% compared to those registered in April of 2019.

Europe’s largest automaker, Volkswagen, reported a 23% decline in deliveries in the first quarter of 2020. Overall Group sales declined by 8.3% and operating profits were down by €3 billion compared to prior year, at €0.9 billion. The deterioration in profit margins is mainly attributed to the lower volumes. As a result, Volkswagen’s operating margin for the first quarter stood at 1.6%, 6.5 basis points lower than that of Q1 2019.

In terms of outlook, automakers with an exposure to China are expecting a quicker recovery in their top line, as encouraging signs from China indicate a pickup in demand. Meanwhile, the recovery in Europe and the US is not expected to occur as fast. Volkswagen expects the volume of global demand for new vehicles to be between 15% and 20% lower for 2020, when compared to the prior year. The second quarter is expected to reflect the full impact of covid-19, followed by a gradual recovery. In comparison, BMW guidelines were more detailed, downgrading its full-year automotive EBIT margin to 0% to 3%, versus the 2% to 4% range estimated before demand was constrained by government restrictions on movement worldwide.

Given the current economic deterioration and material industry headwinds, the impact on automakers is expected to be significant in the short term, followed by a gradual improvement beyond 2020. Nonetheless, the key focus is not only to survive the current slump in demand, but for carmakers to manage not to derail on delivering on their fleet of electric vehicles. The momentum in electric vehicles subsequently lowers the CO2 levels. On this basis, this remains the overarching industry catalyst and the ultimate challenge which should soon regain its focus.

While the covid-19 has led investors to question whether EU 2020 CO2 emission targets will be delayed or postponed, according to the International Council on Clean Transportation (ICCT), the share of electric vehicles by manufacturer are on average 5% higher on a year-to-date basis. Moreover, if the year-to-date emission levels are sustained, the majority of European automakers will manage to meet their targets.

Government stimulus is expected to play a positive role within this space. The recently announced buyer bonus scheme in Germany, which mainly focuses on a temporary reduction in VAT, is a case in point. The fiscal stimulus favours Battery Electric Vehicles over conventional Internal Combustion Engines, and further highlights the push towards electrification.

Nonetheless, the deterioration in profit margins and high capex ratios over the recent years have proved that this shift to electrification is a substantial headwind to profitability. Given the significant capital expenditure that is required and extent of fragmentation of suppliers, consolidation and joint forces are perhaps the way forward for a viable car industry.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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