Asset Allocator’s Soapbox - Transports of delight?
One of the features of the post-crisis global economy is the apparent rude health of some parts of the auto sector, but how has this been achieved and how durable is it? Positive factors include burgeoning emerging market demand, for instance for BMWs, Range Rovers and other luxury marques in China, and potential for demand to pick up in some developed economies. Pent up demand is a feature in markets across the world, as a consequence of the slump in sales following the recession, although some of it may have been dealt with under the various scrappage schemes which brought forward purchases. US consumers may finally feel confident enough to replace vehicles after a decade of postponing purchases. Of course, in the meantime, spares and repairs businesses have been motoring.
In Europe there are clear winners and losers. Although there have been ownership changes and realignments, Saab has been the only serious casualty of the global crisis in autos. Broadly speaking, luxury car makers are now doing better than mass market manufacturers, as demand from the emerging markets and the US plays to their strengths and Europe stagnates/falters. Within Asia, South Korean brands are gaining on, and have in some cases overtaken, the traditional Japanese market leaders in terms of profitability, reliability and quality.
The emerging markets offer clear volume growth potential as car ownership rises along with incomes. China, Brazil, India and Russia all featured in the top ten auto markets in 2011. China overtook the US, in sales, and Japan, in production, as the world’s largest car market in 2009 although the pace of growth since 2010 has moderated. Pollution and congestion will be limiting factors as policy makers there apply the brakes.
How much is due to the cleansing effect of bankruptcy? In the US, the industry cut 1.5 million units of capacity between 2007 and 2012 in order to secure bailout funds. Now, the remaining plants are running at more than 80% capacity. In Europe, where national interests prevented factory closures, capacity utilisation is around 65%, which is not profitable for all the mass producers.
However, even in the US the outlook may be less rosy than the current situation would imply. There are several reasons for this. First, the pattern of car ownership seems to be changing, influenced by both the economic environment and efficiency gains. Congestion and high associated costs – parking, road tolls, fuel and insurance - may dissuade city dwellers from embracing car ownership with the same degree of enthusiasm as in the past. Unemployment amongst the young makes running a vehicle an unaffordable luxury where public transport is available and adequate. Secondly, as cars have become more reliable and possibly less innovative, in terms of design and technology changes, there is less reason to change vehicles as frequently. Polk industry analysis shows that the average length of ownership for US vehicles has increased by 27% compared with pre-recession, to around six years. The average age of the 240 million cars and trucks on the road in the US has risen by 10% to 10.8 years. While some of this ownership extension may be reversed as the economy recovers, it is unlikely to revert completely.
In terms of automotive technology, the green agenda was another victim of the crisis. There have been improvements in mileage but standards vary. Japan and Europe require 54 and 56 miles per gallon, respectively while for China the required standard is 42 mpg and the US a woeful 30 mpg. Piecemeal subsidies and inducements have, so far, failed to encourage wholesale switching to electric and hybrid vehicles. The infrastructure for alternative fuels and electric vehicles has not been built and the lifecycle environmental impact of batteries has been questioned.
However, motoring may be on the move again. This time high fuel prices have come at the same time as there is potential from shale gas as a disruptive technology, holding gas prices down in the US which could lead to a switch away from reliance on gasoline and diesel. The impetus is coming from the freight industry, and is led by economic rather than just environmental motives, which augurs well for the necessary infrastructure changes; Navistar, for example, has been adapting its existing medium and heavy-duty trucks to natural gas/diesel dual-fuel vehicles to meet anticipated demand, while in Europe Volvo has a MethaneDiesel dual-fuel truck. All in all, car and truck sales globally provide fuel, both for stock pickers and asset allocators.
Frances Hudson, Global Thematic Strategist, Standard Life Investments
This article was first published in Professional Adviser on 12th April 2012