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Carmakers face a sales plateau, with an overhaul to follow

by Lou Whiteman  |  Published July 28, 2014 at 3:23 PM

Just a few years removed from a devastating crash, the global auto industry is once again enjoying life in the fast lane. Unfortunately the next round of obstacles could be lurking right around the corner.

Times are good in the auto business. U.S. sales in June continued a steady climb to a seasonally adjusted annual rate of about 16.9 million units, up significantly from a low point of just more than 10 million units sold in 2009 at the height of the recession. The surge has come despite lingering fears about unemployment and the health of the consumer, and has continued even as General Motors Co. has endured an ugly recall controversy.

Industry watchers credit the climb in sales to low borrowing rates and pent up demand from buyers who put off purchases during the recession.

But the automotive sector has always been brutally cyclical, and there is reason to believe today's market in the U.S. and elsewhere is nearing a top. More troubling, some experts believe the next downturn could coincide with a broader trend at least in the western world away from automobiles. If so the industry might be forced to finally deal with a worldwide capacity glut, and the nagging idea voiced by many that the world simply has too many automakers.

Parts suppliers have already started to deal with the changing dynamics of the industry. And carmakers themselves could eventually turn to mergers and acquisitions in an effort to keep up with the altered market. If that happens, the "Big Three" would look a lot different than it does now.

A recent report by AlixPartners lays out the warning signs for the industry. In the U.S. sales are about as good as it gets, the firm said, with growth expected to soon flatten as it pushes near all-time highs and eventually maybe reverse should interest rates rise. Demographics also could play a role by decreasing the number of people with U.S. driver's licenses in the years to come.

In Europe, sales are still 19% below historical peak but, unlike in the U.S., there was no dramatic reduction in the number of manufacturing facilities there during the recession, destroying profitability. AlixPartners estimated that about 57% of European plants are operating below breakeven level, up from 40% in 2007.

In Asia, Japanese automakers -- affected by a weakened yen -- are gearing up to repeat their late '80s expansion push, adding additional competition in established markets and in places like India and Brazil. Meanwhile, China, a bright spot that helped many automakers survive the recession, is slowing. After enjoying an average annual growth rate of 17.6% from 2004 to 2013, AlixPartners predicts the domestic auto market there will only grow 6.3% per year over the next five, and fall further after that.

"The good news is the global auto industry made it through the financial crisis, recession and a whole lot of pain," said John Hoffecker, head of AlixPartners automotive practice. "The bad news is what's ahead is uncertain and unprecedented, and could be painful as well."

Adding to the risk is a fear by some that the car culture has ebbed, putting pressure on sales regardless of where we are in the cycle. Helsinki's ambitious plan announced recently to use technology to make automobiles obsolete in the Finnish capital by 2025 is likely the outlier, but startup transport firms like ZipCar Inc. and Uber Inc. are making inroads in gentrifying U.S. cities and allowing more and more households to avoid owning multiple cars.

A report issued last year by University of Michigan's Transportation Research Institute found that adjusted for population growth in the number of miles driven in the U.S. peaked in 2005 and has dropped steadily thereafter, surprisingly not recovering along with the economy post-recession.

The question is whether in future years there will be enough global sales to support all of the world's automakers? Some of the industry's biggest names fear not. Renault-Nissan CEO Carlos Ghosn, speaking last month at an auto event in Paris, said that he believes his French-Japanese alliance must grow to be among the world's top-three vehicle producers to secure its independence, citing the need to achieve global scale.

"Fifteen years ago, the largest carmakers were not necessarily the most competitive," Ghosn said. "It is now increasingly difficult for small players to remain competitive."

Automakers, he said, can be divided between those who have achieved global economies of scale and those who have not. Ghosn said that his Renault-Nissan, with a little more than 8 million annual units sold, is "not yet among the world's largest." Emerging markets are increasingly important to overall sales, and Ghosn said that in markets like China, India and Brazil upward of 95% of what is sold is manufactured locally.

Today's global "Big Three" would include Toyota Motor Corp., Volkswagen Group AG and General Motors, with plenty of big names including Ghosn's Renault-Nissan, Ford Motor Co., Hyundai Motor Group and Honda Motor Co. Ltd. below looking up. An industry dealmaker said that while those companies are stable and unlikely targets in the near term, "I'd be shocked if within 10 years we are not talking about some sort of a combination between the likes of a Ford or a Honda."

Thanks to the recent upswing most of the largest automakers now enjoy strong balance sheets and need not be in any hurry to make a move, but that could change if sales slow. "We are still way over OEMed," Hoffecker said, referring to a term used for automakers. "How it plays out will come down to execution and the economy."

Many of the near-term risks are based in Europe, where there has already been some shakeout with Volvo Car AB and Saab Automobile AB both sold to Chinese buyers.

Remaining companies including Fiat Chrysler Automobiles NV, an Italian automaker that gained some bulk when it acquired struggling Chrysler out of bankruptcy, and PSA Peugeot Citroën of France likely need additional scale.

Rumors of one such deal, a purchase of Fiat Chrysler by Volkswagen, have popped up repeatedly this summer. Though any talks between the two appear to be in the early stages, a transaction would provide VW with much-needed distribution in the United States, the only major market where the world's No. 2 automaker is lacking. Fiat Chrysler for its part is a patchwork of two struggling automakers that had hoped their combined scale would lead to better results, but which still lag their larger rivals considerably.

Among suppliers a shakeup has already begun. Autoparts makers historically have been jacks of all trade, supplying a wide range of parts and components to carmakers. But that is changing in response to customer demand.

Streamlined automakers are now striving to build similar vehicles worldwide, and need suppliers that can fulfill orders not just to plants in North America and Europe but to India, China and Brazil as well. As a result suppliers have been shuffling assets, attempting to build global reach in specific product areas while shedding operations where they do not rank among the world's largest.

That's part of the motivation behind ZF Friedrichshafen AG's $11 billion approach to fellow airbag and safety products-maker TRW Automotive Holdings Corp., as well as a series of acquisitions and divestitures by the likes of Visteon Corp. and Johnson Controls Inc. in recent years.

Analysts said that while these companies for now have a narrow focus, adding global heft in specific areas, there is no reason to think that the survivors won't eventually turn on each other with the largest suppliers acquiring makers of other components with similar global reach.

Any sort of stress or consolidation by automakers could hasten that process, as suppliers will be motivated to use M&A to diversify their client rosters and better shelter themselves against issues at any one manufacturer.

The past few years in the auto business have been a welcomed respite from the dark days of the great recession, but the industry can only fire on all cylinders for so long. At some point tough questions about overcapacity will have to be answered.

Tags: Carlos Ghosn | Fiat Chrysler Automobiles NV | Ford Motor Co. | General Motors Co. | GM recalls | Honda Motor Co. Ltd. | Hyundai Motor Group | Johnson Controls Inc. | Renault-Nissan | Saab Automobile AB | Toyota Motor Corp. | TRW Automotive Holdings Corp. | Uber Inc. | Visteon Corp. | Volkswagen Group AG | Volvo Car AB | ZF Friedrichshafen AG | ZipCar Inc.

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Lou Whiteman

Senior Writer: Transportation

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