By the time the ink is dry on this article, let alone by the time it is published, it is likely that there will be several more seismic shocks to the economic system and to the automotive industry. It is hard to believe anyone in the automotive industry could look at six months ago as "the good old days," but that is the world we are living in at the moment. Here is a brief recap of the key issues.
For the first time in over 25 years, every segment of the financial system-from traditional banks to investment banks, from private equity to hedge funds-has had major players liquidate or be forced to sell to a more stable competitor. In the past, these kind of economic dislocations were in other industry segments (e.g., automotive or retail) and the financial institutions had a chance to benefit from these changes. This time around, the institutions that provide the "fuel' to our economy are the ones that are in trouble. Although this is probably overstated, it appears that virtually every financial institution of any size jumped on the high reward/high risk bandwagon of the subprime market so no one is really sure when the next financial shoe will drop. As a result, none of these institutions trust each other and they refuse to lend to each other out of fear they will not be repaid.
When fear enters the financial market, banks stop lending to other banks and the entire economy is put at risk. It was this macro credit freeze that led to the Congressional bailout package. Unfortunately, this freeze in credit went on long enough that it will definitely take a while for lending conditions to return to normal even after the positive effects of the bailout legislation begin to be felt. For the automotive industry, it means that 2009 will be a very difficult economic year as even good suppliers have difficulty getting access to credit and many troubled suppliers are likely to tip into bankruptcy.
The freeze in the credit markets has a multiple negative impact on the automotive consumer:
- The virtual elimination of leasing. Leasing has been one of the ways the automotive OEMs have sold higher-mix vehicles (i.e., selling based on a monthly payment level vs. the end value of the vehicle) and shortened the vehicle ownership cycle (2-3 years vs. 4-5). The unavailability of leasing combined with the difficult economic conditions may put pressure on the higher-content vehicles in 2009.
- Limited credit availability. Only the best borrowers will be able to finance a vehicle. Access to credit will remain constrained for most of 2009.
- Negative impact on consumer confidence. While the accompanying chart (p. 14) showing consumer sentiment indicates that consumer confidence went up a bit in September, this was before the bailout crisis. This reinforces that even if people can afford to buy a car, they are holding off any kind of durable goods purchases until they feel better about the overall economy.
- Limited Recovery in Housing in 2009. Housing is unlikely to improve in 2009 for a variety of reasons. Given the strong correlation between housing and vehicle sales (and, in particular, pickup truck sales), this will keep downward pressure on automotive sales for the next 6-12 months.
For the first time in recent memory, even Toyota and Honda are having difficulty selling vehicles. Toyota's sales were down 32% in September 2008 from the previous year, and Honda was down 24%. One thing to keep in mind, though, is that things have actually been much worse in the automotive industry. For those of us that have been around for a while, the most significant downturn since World War II occurred in 1982, as shown in the accompanying chart. So while potential production numbers of 12.3 million to 12.7 million for 2009 sound horrible, from a historical perspective they do not look quite that bad. The main message from 2008 is that the automotive industry is still a cyclical industry and that suppliers and OEMs need to develop a better capability of adjusting their business models to the inevitable changes in the market.
Remember Fuel Prices?
While it now seems like ancient history, prior to the credit crunch the significant increase in fuel prices was the big story in the automotive industry. There is little question that the surge in fuel prices has led to a major short-term shift in consumer buying habits with small cars and fuel-efficient small SUVs doing relatively well while full size pickup truck sales continue to decline (e.g., Ford F Series pickup trucks were down 42% from year ago level). We want to stress, however, that pickup truck sales will come back once housing starts begin to recover. Unfortunately, with the lack of sales in 2008 and the number of low-mileage used pickups that will be available in 2009, new pickup truck sales will probably not begin to recover until 2010.
One final note of caution.
OEMs and suppliers should not bet too heavily on everyone driving a car rather than a light truck in the future, either. We believe that improvements in powertrain fuel efficiency and the acceleration of lightweight materials will result in the continued vibrancy of the light-truck segment, although most of them will now be built on a crossover platform. The message is to be flexible enough to change with market and economic conditions and not to be too dependent on any one segment.
Although it has ended up being a footnote in the media frenzy over the credit crisis, Congress did pass a $25-billion loan package for the automotive industry to invest in more fuel-efficient technology. This is a huge positive for the industry and gives the traditional Big 3 some breathing room during the very difficult transition they are facing over the next 2 to 3 years. Suppliers should look for opportunities to benefit from this new funding, both through the OEMs and directly.
The biggest issue for most industry participants is the speed with which all these changes have happened. From the surge in fuel prices to the end consumer, to the increase in raw material prices for suppliers and OEMs, to the dramatic drop in traditional light-truck sales, 10 years' worth of change seems to have been crammed into 6 to 8 months. Whether this speed of change should now be considered typical or whether 2008 will go down as a "perfect storm" of events is unknown. What is clear is the ability to rapidly adjust your business model to major changes in the market will be a key to future success. Many people remember Charles Darwin's adage as "Survival of the Fittest". But what he actually said was that those who survive are the fastest to adapt. His theory was never more relevant than it is today.