28 Oct 2015
These two dynamics are creating a 'new normal' with opportunities and risks for all industry players.
" The companies that can successfully navigate their business into new normal will be the industry leaders of the future."
Alex Kewley and Mark CherryDirector, Client Insights & Solutions and Head of Global Diversified Industries Europe and Global Subsidiaries Group Network Countries
There are many headlines covering the inevitable move towards widespread use of autonomous shared electric vehicles. Advances in technology are facilitating it and regulatory pressure demanding it but the real underlying driver is changing behaviour.
Customers are increasingly prioritising connectivity over the pleasure of being behind a wheel and in doing so are increasingly leasing the ability to get from A to B. The car becomes less important than the technology in the car and the convenience with which it is available. Invariably, this shift means less vehicles on the road, readily available at a low cost.
As a petrolhead, I was shocked when my nephew, who had just passed his driving test, turned down the offer of borrowing my pride and joy for the weekend to take the train because “it has wi-fi now".
This shift is putting significant pressure on original equipment manufacturers to innovate their way to relevance. At the very least, it materially changes how consumers view brands and how they buy or lease vehicles. At worst, it could relegate personal car ownership to a cottage industry.
However, these headline-grabbing possibilities skip over a $US9 trillion global industry which is alive and well today. There are many other trends impacting the industry value chain and auto firms need to be able to manage these in parallel.
We believe there are three other near-term trends which we believe demand a response from the industry today.
Asia has become the most important region for the industry and even with a deceleration is anticipated to account for 60 per cent of new vehicles bought before 2020. Of course 'Asia' comprises many markets with intricate differences but one core driver is consistent – the creation of new middle classes through economic growth, urbanisation and rising wealth.
By 2030 the global middle class will hit nearly five billion. Asia's share will double, with the region accounting for over 60 per cent of all middle classes and over 40 per cent of middle-class consumption.
Key markets driving this will be China, India, Indonesia, Vietnam, Thailand and Malaysia – in some of which the average cars-per-household is around 10 per cent of that in the West.
It is not just demand. Production has long been moving east - initially aimed at reducing costs and dealing with overcapacity in the West and now increasingly to service rising local demand. This will continue as suppliers build out their Asia presence and bring core operations to the region.
China may be slowing down but it will remain a huge incremental growth market and the world's largest producer. Moreover, China's supply chains are increasingly tied to the ASEAN nations in a 'Factory Asia' which produces almost half of the world's goods. The wider south east Asia region will see significant growth in car production of over two million vehicles by 2020.
Key for the future industry leaders is positioning their business and products to capture this Asian demand and taking advantage of the rising production hubs.
So how will the industry fund this growth and adapt their funding sources? Manufacturers and suppliers have almost $A400 billion of debt maturing over the next 10 years. Despite Asia being the largest automotive market, the portion of this debt in Asia Pacific currencies remains relatively small.
However, it would be wrong to conclude the industry is myopic on Asian growth. The reality is the Asian financial markets are not ready. Many of the typical funding sources used in the west by the industry are either unavailable or too inflexible. This is compounded by the availability of cheap liquidity in the West today as an alternative to local funding.
As interesting as how many vehicles are bought in Asia is also how vehicles are bought. Auto finance penetration varies between countries but the use of automobile finance for purchases across the globe is around 70 per cent compared with around 50 per cent in Asia and less than 20 per cent in the largest global market of China. In the new normal of shared autonomous vehicles, the landscape of who actually owns vehicles will change and, as a result, what needs to be financed and how.
The challenge is adapting to the new normal and the most effective funding source. Across Asia, finance may need to be readily available and attractive in order to achieve this demand (see ANZ's recent Caged Tiger paper for more).
Finally and perhaps most critically is the impact the new normal has on the supply chain. Cars are becoming increasingly sophisticated, driven by consumers and regulators demanding lightweight, active safety and connectivity as standard.
In order to remain competitive, models are now more expensive to manufacture and have shorter lifespans. The long-term trends of automation and electrification are also attracting powerful new players and adding to competitive pressure (I'm not sure I'd want to go up against Apple and Google in any product field!).
Those that innovate and provide value-add technological components will gain a larger share of the margin in a vehicle and become customer facing industry leaders. Those that cannot will struggle financially or be absorbed. Consolidation is already on the rise in the sector, with the number of supplier M&A deals up 150 per cent in 2014.
ANZ recently analysed 5000 companies in the automotive supply chain and found that credit metrics are diverging. The smaller upstream tier-two suppliers have weaker credit metrics, longer working capital cycles and higher costs of capital than their larger downstream tier-one and original equipment manufacturer (OEM) partners.
In Asia this is amplified, where heavy investment and increasing competition has have a noticeable impact and the prospect of rising interest rates is a dark cloud on the horizon.
As the industry changes, there is a clear opportunity for all participants to position their business for growth. Equally, there is a clear opportunity for the large downstream OEMs and tier 1 suppliers to use their financial strength to support – or absorb – important suppliers in a way both find mutually beneficial.
Far from the global automotive industry being doomed, it continues to grow. But it is also changing fundamentally. And while the challenges are very real, the opportunity is also there for companies that adapt to the new normal to be part of one of the most exciting global industries.
Alex Kewley CFA is Director, Client Insights & Solutions and Mark Cherry is Head of Global Diversified Industries Europe, and Head of Global Subsidiaries Group Network Countries at ANZ.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
28 Oct 2015
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