Auto Market Update: How COVID-19 is impacting the Global Auto Industry
March 13, 2020
|
Dealer Finance
- Keywords:
- covid-19
March 13, 2020
|
Dealer Finance
Will COVID-19 Sicken Cars-20?
A Publication of BMO Capital Markets Economic Research • Erik Johnson, Economist, BMO Financial Group
Highlights
• Vehicle demand was already expected to decelerate in 2020, but COVID-19 will further depress sales
• Purchases are likely to fall by 11% in Canada and 9% in the U.S. in Q2 compared to 2019
• Lower interest rates will support the recovery
Easing up on the Gas Pedal
Consumers in Canada and the United States have continued to tap the brakes on motor vehicle purchases. After peaking in 2016, combined sales volumes have dropped back below the 19 million mark for the first time since 2015. In 2020, we see these late-cycle dynamics persisting and COVID-19 related uncertainty driving vehicle sales down another 3.7%. Concerns about COVID-19’s impact on the global auto industry are also evolving. While it’s still too early to grasp its full scope, sales in North America will likely be weaker in 2020 H1 than in H2.
In the United States, sales volumes fell 1.9% in 2019. In Canada, the market decelerated harder with sales cooling by 3.7%. The market is being pulled in opposing directions by forces on the demand side. Debt remains a drag on sales in Canada, while demographics are restricting demand in the United States. Auto loan growth had been slowing in both countries, also limiting sales. With the Bank of Canada and the Federal Reserve cutting rates aggressively, sales will likely adjust downward slowly. But the risk is that uncertainty over COVID-19 will lead households to hit the brakes harder on sales.
With lower sales volumes, competition among automakers will ratchet up. Producers with better concentration in growing product segments (i.e., light trucks) are positioned to benefit more in the near-term. This trend will only be accommodated by lower gas prices. For dealerships, inventory mix will remain an important factor in driving growth. Some may experience a rougher transition from past supply mismanagement.
U.S.: Mixed Signals
U.S. vehicle sales are poised to downshift moderately given late-cycle conditions, with steady employment growth supporting demand above historical trends. With added downward pressure from COVID-19, we expect the pace to fall below 16.4 million units in 2020.
Several demand factors are sending weaker signals. Vehicle saturation continues to put downward pressure on sales as the ownership rate is above its peak in the past cycle (at more than one vehicle per person of driving age). Slowing population growth, coming in at only 0.5% for 2019, is curbing demand, and will be an ongoing headwind for the U.S. market. The improving durability of motor vehicles could temper sales going forward. In 2019, the average vehicle age crept up to an all-time high of 11.8 years—an increase of 1.7 years compared to a decade ago. Financing trends in the industry seem to be adjusting to the increase in vehicle durability as the average term for a new car loan reached 68.9 months in 2019, up from 62 months a decade ago according to Experian. While this may match vehicle age patterns, the potential for creating negative equity for American households is an issue to keep an eye on.
Partially counteracting these headwinds to demand are rate cuts by the Federal Reserve and steady job growth. If downward pressure on other rates spills over to auto loans, this will extend the lengthy cycle further. For now, conditions in the auto credit market suggest the downward trend in the U.S. market will persist. Signals of loan demand and credit standards remain relatively flat after showing signs of tightening). Interest rates on new auto loans, while above their trough in 2016, are expected to decline as the Fed eases policy.
A key secular trend is the changing composition of sales. Consumers have shifted toward light trucks at the expense of the (conventional) passenger car. The halving of oil prices from June 2014 to January 2015, where they’ve more or less remained until the recent slide, likely helped things along. As a result, sales are shifting to richer product segments to the benefit of producers with more market share in that space.
On the supply side, manufacturers have been deftly responding to demand-side pressures. Automakers scaled back production in the United States by 4.9% in 2019. But the average betrays a 14.8% drop in passenger car production compared to only a 1.7% decline for light trucks. Ford, for instance, is highlighting only one car in its showcases for 2020, the Mustang, which admittedly is a halo product, while it phases out its other remaining passenger car, the Fusion. This pivot by manufacturers has helped dealership inventories adjust. Expect this trend to reduce the need for incentive spending and shift sales to higher-margin products, thereby boosting dealerships’ profitability. However, with the potential fallout from COVID-19, lower inventories also expose automakers and dealerships to more downside risk if supply-chain disruptions last longer than anticipated.
Canada: Debt is a Downer
In 2019, regional sales trends in Canada showed significant dispersion. There was a clear East-West divide with the West experiencing declines in light vehicle sales in excess of 5%. Ontario, Quebec, and the Atlantic Provinces, on the other hand, experienced milder sales reductions of around 2% or less. We anticipate that growth in Quebec and the Maritimes will slow in 2020. With WTI plunging below $35, provincial sales dispersion is likely to widen and contribute to slower overall vehicle sales in Canada, likely below 1.9 million units by the end of the year [1].
The secular movement toward the light truck segment is even more pronounced in Canada compared to the U.S. Autos have never recovered from their Great Recession plunge. Consumers’ changing tastes have further diminished car sales in Canada, as light trucks comprised 75.6% of the market in 2019 compared with 49.3% back in 2007. This is moving consumers to more expensive vehicles to the benefit of producers. However, higher average vehicle prices are likely to lessen demand going forward. At the aggregate level, as in the U.S., cyclical demand factors are sending mixed messages on where the market is heading.
Household debt remains the largest drag on auto demand in Canada. Canadians, on average, are allocating 15% of their household income to service debt payments as of 2019Q4. The household debtservice ratio is now above its peak during the Great Recession despite much lower rates. This stands in sharp contrast to the U.S. where the comparable ratio is at record lows going back to the 1980s. With concerns over COVID-19 leading the Bank of Canada to cut rates, Canadian households will see some relief.
According to J.D. Power, 71% of new car purchases are being financed over terms exceeding six years. This compares to only 14% of auto loans back in 2008. Average bank financing rates for new auto loans are still more than 50 bps above their 2017 lows. But, with recent easing by the Bank of Canada, auto loan rates could fall, which would support vehicle sales.
On the positive side, demographics and a healthy labour market have reinforced vehicle sales. Population growth in 2019 was the fastest in three decades at 1.5%, which we see helping to sustain Canadian sales above their previous cyclical highs. Despite middling employment numbers across the Prairies in 2019, national employment growth remained robust at 2.1%. We see it cooling to 0.6% this year, which is consistent with vehicle sales softening in 2020.
The supply-side of the market responded sharply to the ongoing shifts in consumer tastes with passenger-car production falling 28.9% in 2019 while light trucks were up 7.1%, leaving overall production down 4.9%. And, the near-closure of GM’s Oshawa plant (it is retaining 300 employees) and the recent announcement of FCA Windsor’s third shift shuttering effective June 29 will likely see Canada further reduce its production volume in 2020, as together they represented 15.4% of national vehicle production in 2019.
Following the overall industry trend, average sales per dealership fell to 517 units compared to 530 in 2018. However, better alignment with developments in the sector by certain firms and dealerships led to improved performance. In growth terms, Lexus, Volvo, Toyota, Hyundai, and Kia rounded out the top five with year-over-year increases in sales per dealership of at least 15 units, while also outperforming the Canadian light vehicle sales market. This reinforces the view that suppliers able to respond to industry dynamics will be more profitable at this stage of the cycle.
For dealers, emerging risks include the potential for the USMCA to raise average vehicle prices and the possibility of a federal luxury vehicle tax. When the new trade agreement comes into force, possibly this summer, the North American rules of origin (ROO) requirements will increase from 62.5% to 75% by 2023. The higher ROO thresholds, along with the added labour value content (LVC) and steel and aluminum minimums, will require some producers to adjust their North American vehicle production if they wish to remain compliant. Producers may respond by switching from their cost-minimizing parts suppliers to North American alternatives or maintain their supplier network and instead pay the 2.5% import tariff. Both of these alternatives would contribute to higher overall vehicle prices and put more downward pressure on sales.
The luxury tax would have a similar effect on prices and vehicle demand, albeit with more of a concentrated effect on the Vancouver and Toronto markets where most luxury vehicles are sold. The luxury vehicle tax implemented by the B.C. government in April 2018 provides evidence of the possible effects of a federal tax. Luxury truck sales (think Audi, BMW, Jaguar, Maserati, Mercedes, and Porsche) were growing by at least 5% y/y in Ontario and B.C. when the tax was introduced. Afterward, sales in B.C. decreased by more than 10% y/y in 2018Q3 compared to a nearly 10% y/y increase in Ontario. Ontario luxury truck sales have continued to grow faster than the overall segment, while in B.C. they were lagging the overall trend as of 2019Q1. For luxury car sales, the secular movement away from passenger cars has dominated any further downside pressure from the tax in B.C. For luxury dealers, it appears that the burden of a federal tax is more likely to fall on their light truck sales, and so maintaining service and aftermarket customer relationships would be increasingly important under that scenario. However, since being included in Finance Minister Morneau’s mandate letter, the luxury vehicle tax has only seen brief coverage in the Finance and International Trade Committees during the 43rd Parliament. With the announcement on Windsor’s third shift and COVID-19 concerns, the government might be reluctant to move forward with adding further downside pressure on the auto industry at this time.
COVID-19: Making a Slower Year Worse
It was already looking like a down-year for the global auto industry even before the outbreak of novel coronavirus. Emission standards' compliance has been weighing heavily on sales in Europe, and North American sales had been declining in late-cycle fashion. Understandably, COVID-19 has led some to take a more pessimistic view of the sector for 2020. For example, Moody’s revised down its projection to a 2.5% decline in global sales from 0.9%. Automobile purchases, like all durables, can typically be postponed over the near-term and, so, are at greater risk of declining as a result of the uncertainty caused by the spread of the virus than say consumer staples. We remain more bearish on U.S. vehicle sales, with a forecasted decline of 3.6%, than many of the revised forecasts. At the moment, most of the initial effects of the outbreak are being felt in China, with sales down 80% y/y in February.
Attention is also now turning to China’s role in global supply chains and, for some automakers, the downside risks remain high. Global supply chains have become highly complex. One recent study of Toyota's supply chain showed it relied on 2,192 distinct firms [2]. The spillover effects of disruptions in one part of a network can therefore be difficult to predict. Toyota has indicated it is receiving parts from China for its 16 facilities in Japan, but will reassess its ability to maintain its operations beginning the week of March 9. The outbreak recently led Lamborghini to close its factory for two weeks. The quarantine measures imposed in Italy will also add further pressure on FCA's production network. Any further closures would be damaging for the global industry, but indications so far are that North American producers are relatively better positioned to weather the disruptions in the near-term. Part of this goes back to the trade war with China, which led some North American automakers to reduce their dependence on Chinese suppliers. U.S. imports of motor vehicle parts from China over this period are consistent with this anecdotal evidence, showing a significant drop-off after tariffs rose from 10% to 25% in May 2019 (Chart 7). If the supply disruptions stretch into April, however, expect the situation to worsen for North American producers as well.
The Auto Cycle: It Goes On and On My Friend
Another important secular trend in the auto sector has been the lengthening of the cycle since the 1960s. Manufacturing is highly cyclical and it is important to understand what point of the cycle the industry is in for both investors and firms for allocating capital. The puzzle over the last two cycles, in particular, has been why they are lasting longer than they used to. The reduction in the volatility of macroeconomic indicators since the 1980s is cited as one cause of extending business cycles. This has been attributed to the increasing sophistication of monetary policy tools and a shift toward inflation targeting. U.S. Real GDP, unemployment, and industrial production have seen their volatility fall by at least half comparing the 1948-to-1984 period with the post-1985 period. At the same time, the volatility of consumer sentiment shifts and oil price shocks have not fallen by nearly the same factor, adding weight to the notion that central banks have become more effective at stabilizing the macroeconomy.
The rising role of services in advanced economies is also emerging as a key contributor to the lengthening of the cycle. From the late 1960s, services have gone from just over 50% of nominal GDP to more than 70% in Canada and the United States. Services are much less cyclical than the goods sector, so GDP will be less cyclical as services continue their increasing importance in the economy. The bottom line is bank on generally longer recoveries from future recessions and, hence, longer auto sales cycles.
Endnotes:
[1] For a fuller picture of our Provincial forecasts see the BMO Economics Provincial Monitor for February 2020
Read more
Will COVID-19 Sicken Cars-20?
A Publication of BMO Capital Markets Economic Research • Erik Johnson, Economist, BMO Financial Group
Highlights
• Vehicle demand was already expected to decelerate in 2020, but COVID-19 will further depress sales
• Purchases are likely to fall by 11% in Canada and 9% in the U.S. in Q2 compared to 2019
• Lower interest rates will support the recovery
Easing up on the Gas Pedal
Consumers in Canada and the United States have continued to tap the brakes on motor vehicle purchases. After peaking in 2016, combined sales volumes have dropped back below the 19 million mark for the first time since 2015. In 2020, we see these late-cycle dynamics persisting and COVID-19 related uncertainty driving vehicle sales down another 3.7%. Concerns about COVID-19’s impact on the global auto industry are also evolving. While it’s still too early to grasp its full scope, sales in North America will likely be weaker in 2020 H1 than in H2.
In the United States, sales volumes fell 1.9% in 2019. In Canada, the market decelerated harder with sales cooling by 3.7%. The market is being pulled in opposing directions by forces on the demand side. Debt remains a drag on sales in Canada, while demographics are restricting demand in the United States. Auto loan growth had been slowing in both countries, also limiting sales. With the Bank of Canada and the Federal Reserve cutting rates aggressively, sales will likely adjust downward slowly. But the risk is that uncertainty over COVID-19 will lead households to hit the brakes harder on sales.
With lower sales volumes, competition among automakers will ratchet up. Producers with better concentration in growing product segments (i.e., light trucks) are positioned to benefit more in the near-term. This trend will only be accommodated by lower gas prices. For dealerships, inventory mix will remain an important factor in driving growth. Some may experience a rougher transition from past supply mismanagement.
U.S.: Mixed Signals
U.S. vehicle sales are poised to downshift moderately given late-cycle conditions, with steady employment growth supporting demand above historical trends. With added downward pressure from COVID-19, we expect the pace to fall below 16.4 million units in 2020.
Several demand factors are sending weaker signals. Vehicle saturation continues to put downward pressure on sales as the ownership rate is above its peak in the past cycle (at more than one vehicle per person of driving age). Slowing population growth, coming in at only 0.5% for 2019, is curbing demand, and will be an ongoing headwind for the U.S. market. The improving durability of motor vehicles could temper sales going forward. In 2019, the average vehicle age crept up to an all-time high of 11.8 years—an increase of 1.7 years compared to a decade ago. Financing trends in the industry seem to be adjusting to the increase in vehicle durability as the average term for a new car loan reached 68.9 months in 2019, up from 62 months a decade ago according to Experian. While this may match vehicle age patterns, the potential for creating negative equity for American households is an issue to keep an eye on.
Partially counteracting these headwinds to demand are rate cuts by the Federal Reserve and steady job growth. If downward pressure on other rates spills over to auto loans, this will extend the lengthy cycle further. For now, conditions in the auto credit market suggest the downward trend in the U.S. market will persist. Signals of loan demand and credit standards remain relatively flat after showing signs of tightening). Interest rates on new auto loans, while above their trough in 2016, are expected to decline as the Fed eases policy.
A key secular trend is the changing composition of sales. Consumers have shifted toward light trucks at the expense of the (conventional) passenger car. The halving of oil prices from June 2014 to January 2015, where they’ve more or less remained until the recent slide, likely helped things along. As a result, sales are shifting to richer product segments to the benefit of producers with more market share in that space.
On the supply side, manufacturers have been deftly responding to demand-side pressures. Automakers scaled back production in the United States by 4.9% in 2019. But the average betrays a 14.8% drop in passenger car production compared to only a 1.7% decline for light trucks. Ford, for instance, is highlighting only one car in its showcases for 2020, the Mustang, which admittedly is a halo product, while it phases out its other remaining passenger car, the Fusion. This pivot by manufacturers has helped dealership inventories adjust. Expect this trend to reduce the need for incentive spending and shift sales to higher-margin products, thereby boosting dealerships’ profitability. However, with the potential fallout from COVID-19, lower inventories also expose automakers and dealerships to more downside risk if supply-chain disruptions last longer than anticipated.
Canada: Debt is a Downer
In 2019, regional sales trends in Canada showed significant dispersion. There was a clear East-West divide with the West experiencing declines in light vehicle sales in excess of 5%. Ontario, Quebec, and the Atlantic Provinces, on the other hand, experienced milder sales reductions of around 2% or less. We anticipate that growth in Quebec and the Maritimes will slow in 2020. With WTI plunging below $35, provincial sales dispersion is likely to widen and contribute to slower overall vehicle sales in Canada, likely below 1.9 million units by the end of the year [1].
The secular movement toward the light truck segment is even more pronounced in Canada compared to the U.S. Autos have never recovered from their Great Recession plunge. Consumers’ changing tastes have further diminished car sales in Canada, as light trucks comprised 75.6% of the market in 2019 compared with 49.3% back in 2007. This is moving consumers to more expensive vehicles to the benefit of producers. However, higher average vehicle prices are likely to lessen demand going forward. At the aggregate level, as in the U.S., cyclical demand factors are sending mixed messages on where the market is heading.
Household debt remains the largest drag on auto demand in Canada. Canadians, on average, are allocating 15% of their household income to service debt payments as of 2019Q4. The household debtservice ratio is now above its peak during the Great Recession despite much lower rates. This stands in sharp contrast to the U.S. where the comparable ratio is at record lows going back to the 1980s. With concerns over COVID-19 leading the Bank of Canada to cut rates, Canadian households will see some relief.
According to J.D. Power, 71% of new car purchases are being financed over terms exceeding six years. This compares to only 14% of auto loans back in 2008. Average bank financing rates for new auto loans are still more than 50 bps above their 2017 lows. But, with recent easing by the Bank of Canada, auto loan rates could fall, which would support vehicle sales.
On the positive side, demographics and a healthy labour market have reinforced vehicle sales. Population growth in 2019 was the fastest in three decades at 1.5%, which we see helping to sustain Canadian sales above their previous cyclical highs. Despite middling employment numbers across the Prairies in 2019, national employment growth remained robust at 2.1%. We see it cooling to 0.6% this year, which is consistent with vehicle sales softening in 2020.
The supply-side of the market responded sharply to the ongoing shifts in consumer tastes with passenger-car production falling 28.9% in 2019 while light trucks were up 7.1%, leaving overall production down 4.9%. And, the near-closure of GM’s Oshawa plant (it is retaining 300 employees) and the recent announcement of FCA Windsor’s third shift shuttering effective June 29 will likely see Canada further reduce its production volume in 2020, as together they represented 15.4% of national vehicle production in 2019.
Following the overall industry trend, average sales per dealership fell to 517 units compared to 530 in 2018. However, better alignment with developments in the sector by certain firms and dealerships led to improved performance. In growth terms, Lexus, Volvo, Toyota, Hyundai, and Kia rounded out the top five with year-over-year increases in sales per dealership of at least 15 units, while also outperforming the Canadian light vehicle sales market. This reinforces the view that suppliers able to respond to industry dynamics will be more profitable at this stage of the cycle.
For dealers, emerging risks include the potential for the USMCA to raise average vehicle prices and the possibility of a federal luxury vehicle tax. When the new trade agreement comes into force, possibly this summer, the North American rules of origin (ROO) requirements will increase from 62.5% to 75% by 2023. The higher ROO thresholds, along with the added labour value content (LVC) and steel and aluminum minimums, will require some producers to adjust their North American vehicle production if they wish to remain compliant. Producers may respond by switching from their cost-minimizing parts suppliers to North American alternatives or maintain their supplier network and instead pay the 2.5% import tariff. Both of these alternatives would contribute to higher overall vehicle prices and put more downward pressure on sales.
The luxury tax would have a similar effect on prices and vehicle demand, albeit with more of a concentrated effect on the Vancouver and Toronto markets where most luxury vehicles are sold. The luxury vehicle tax implemented by the B.C. government in April 2018 provides evidence of the possible effects of a federal tax. Luxury truck sales (think Audi, BMW, Jaguar, Maserati, Mercedes, and Porsche) were growing by at least 5% y/y in Ontario and B.C. when the tax was introduced. Afterward, sales in B.C. decreased by more than 10% y/y in 2018Q3 compared to a nearly 10% y/y increase in Ontario. Ontario luxury truck sales have continued to grow faster than the overall segment, while in B.C. they were lagging the overall trend as of 2019Q1. For luxury car sales, the secular movement away from passenger cars has dominated any further downside pressure from the tax in B.C. For luxury dealers, it appears that the burden of a federal tax is more likely to fall on their light truck sales, and so maintaining service and aftermarket customer relationships would be increasingly important under that scenario. However, since being included in Finance Minister Morneau’s mandate letter, the luxury vehicle tax has only seen brief coverage in the Finance and International Trade Committees during the 43rd Parliament. With the announcement on Windsor’s third shift and COVID-19 concerns, the government might be reluctant to move forward with adding further downside pressure on the auto industry at this time.
COVID-19: Making a Slower Year Worse
It was already looking like a down-year for the global auto industry even before the outbreak of novel coronavirus. Emission standards' compliance has been weighing heavily on sales in Europe, and North American sales had been declining in late-cycle fashion. Understandably, COVID-19 has led some to take a more pessimistic view of the sector for 2020. For example, Moody’s revised down its projection to a 2.5% decline in global sales from 0.9%. Automobile purchases, like all durables, can typically be postponed over the near-term and, so, are at greater risk of declining as a result of the uncertainty caused by the spread of the virus than say consumer staples. We remain more bearish on U.S. vehicle sales, with a forecasted decline of 3.6%, than many of the revised forecasts. At the moment, most of the initial effects of the outbreak are being felt in China, with sales down 80% y/y in February.
Attention is also now turning to China’s role in global supply chains and, for some automakers, the downside risks remain high. Global supply chains have become highly complex. One recent study of Toyota's supply chain showed it relied on 2,192 distinct firms [2]. The spillover effects of disruptions in one part of a network can therefore be difficult to predict. Toyota has indicated it is receiving parts from China for its 16 facilities in Japan, but will reassess its ability to maintain its operations beginning the week of March 9. The outbreak recently led Lamborghini to close its factory for two weeks. The quarantine measures imposed in Italy will also add further pressure on FCA's production network. Any further closures would be damaging for the global industry, but indications so far are that North American producers are relatively better positioned to weather the disruptions in the near-term. Part of this goes back to the trade war with China, which led some North American automakers to reduce their dependence on Chinese suppliers. U.S. imports of motor vehicle parts from China over this period are consistent with this anecdotal evidence, showing a significant drop-off after tariffs rose from 10% to 25% in May 2019 (Chart 7). If the supply disruptions stretch into April, however, expect the situation to worsen for North American producers as well.
The Auto Cycle: It Goes On and On My Friend
Another important secular trend in the auto sector has been the lengthening of the cycle since the 1960s. Manufacturing is highly cyclical and it is important to understand what point of the cycle the industry is in for both investors and firms for allocating capital. The puzzle over the last two cycles, in particular, has been why they are lasting longer than they used to. The reduction in the volatility of macroeconomic indicators since the 1980s is cited as one cause of extending business cycles. This has been attributed to the increasing sophistication of monetary policy tools and a shift toward inflation targeting. U.S. Real GDP, unemployment, and industrial production have seen their volatility fall by at least half comparing the 1948-to-1984 period with the post-1985 period. At the same time, the volatility of consumer sentiment shifts and oil price shocks have not fallen by nearly the same factor, adding weight to the notion that central banks have become more effective at stabilizing the macroeconomy.
The rising role of services in advanced economies is also emerging as a key contributor to the lengthening of the cycle. From the late 1960s, services have gone from just over 50% of nominal GDP to more than 70% in Canada and the United States. Services are much less cyclical than the goods sector, so GDP will be less cyclical as services continue their increasing importance in the economy. The bottom line is bank on generally longer recoveries from future recessions and, hence, longer auto sales cycles.
Endnotes:
[1] For a fuller picture of our Provincial forecasts see the BMO Economics Provincial Monitor for February 2020
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