Auto industry post Covid-19: Stewardship of cash and capital

Over the past five years, the auto industry has been busy transforming its tired image into that of a tech-oriented sector, engaged with smart, connected and electrified vehicles and mobility services. Mid-stride through this capital intensive transition, Covid-19 has dealt a blow, leading to a simultaneous collapse of both supply and demand.

If the global auto industry were a nation, it would rank #4 among the largest economies. It employs over 50 million people, directly and indirectly. Most nations and millions of wage earners have a keen interest in how this industry navigates its recovery.

Analysts expect that for 2020, global demand will drop by over 25 per cent and revenue shortfall will cross $100 billion — and these estimates will undergo change. Sales in the US have temporarily dropped to levels seen only in 2010, after GM and Chrysler had filed for bankruptcy. For a fast-growing market like India, demand is expected to drop to a five-year low, compounding aggravations for an industry in the midst of a complicated migration to BS-VI emission standards which has consumed investment in excess of ₹60,000 crore.

Recovery from the effects of this pandemic faces the twin risks of a slow calibrated restarting of the economy and the spectre of a second wave of Covid. Further, the trajectory will be influenced by a complex interplay of consumer sentiments, government stimulus and industry actions.

Consumer sentiments and government stimulus

Across the globe, lockdowns have idled many businesses and a good fraction of workforce has been under-employed, leaving their financial reserves depleted and credit lines stretched. Furthermore, new habits acquired during the lockdown, including work-from home and teleconferencing, promise to usher a new work culture where less travel will be required.

And then there are second order effects. By April, weak demand in Europe and the US has resulted in a glut of unsold used cars whose residual values continue to decline. These factors will collectively hurt new vehicle sales. Automakers are hoping that demand drop will be mitigated after Covid-19, as many commuters indoctrinated with social-distancing would be disinclined to share rides or use crowded mass transit, and prefer personal transport.

A decade sustained by liberal doses of financial stimuli had led to a pre-Covid situation where credit risk, liquidity risk and equity risk had all been under-appreciated by financial markets. Now, when we most urgently need such boosters, the risks may no longer be ignored. Bravely, most governments have announced unprecedented measures to ensure sufficient liquidity to avoid stalling the anticipated recovery. Western automakers have amassed reserves and credit lines in excess of $120 billion — yet this would be barely enough to see them through two quarters if recovery is slow. These additional credit lines are increasingly expensive as rating agencies have downgraded most auto stocks.

Industry actions

As an industry accustomed to business cycles, the first order of business has been cash conservation. This time though, the cuts are deeper and will be felt for much longer. Almost all auto plants in Europe and the US have seen closures to reduce expenses. Most US automakers have already declared “pencils-down”, deferring work on near-term product upgrades and launches.

At the same time, automakers will accelerate exits from many unprofitable regions and product segments. It is hard to believe that Ford and GM are realigning as regional players focussed on North America. They have also shed most passenger car segments in favour of profitable crossovers and SUVs. Since Covid-19, Renault has also been compelled to reluctantly walk away from the Chinese market. One may expect more such market and product segment exits in the year ahead.

The second lever has involved re-scaling investment. Abandoning the industry’s transformation to smarter, greener and connected mobility does not appear to be an option. However, more efficient allocation of precious capital will be necessary. Even cash-rich Toyota has used cross-holdings to extend its hegemony over Subaru, Mazda and Suzuki and with it, leverage capital in select markets (with Suzuki in India) and product segments (with Mazda for sport-sedans).

GM with Honda, and VW with Ford, are examples of automakers pooling investment to acquire expensive electrification and autonomous driving technologies. BMW and Daimler merged their investments in mobility services where profits will take a long time to materialise. One may expect more partnering in the coming months.

New wave of consolidation

An industry that orchestrates over a thousand auto production plants across the world will face a new wave of consolidation and resizing. The announced merger between Fiat-Chrysler and Peugeot (PSA) in their quest for economies of scale will trigger others. Chinese automakers particularly seem poised to go on the offensive. Geely, for one, has publicly stated its ambition to spur industry consolidation. Their merger with Volvo Cars and their stakes in Volvo Trucks and Daimler are evidence.

Governments in US and Europe have already signalled their wariness to seeing some of their flagship brands acquired by opportunistic Chinese investors who enjoy state patronage. In a world disenchanted with a dysfunctional WTO, the knives are out and it’s each economy for itself as they seek to safeguard their future.

Chastened by the recent experience when medical supplies and test kits were difficult to source, nations have also seen the need for better self-reliance and this policy will find resonance across strategic industry sectors. For the auto industry, efficiencies that were sought through optimising global sourcing will be rebalanced to favour resilience. Growing nationalism and regional focus will see the auto industry re-architect its supply chains with an emphasis on on-shore or near-shore suppliers.

Revamped retail architecture

At the same time, customers who are now accustomed to a wider range of digital interactions will require that the auto industry revamp its retail architecture. The high cost of urban real-estate, precious capital tied up in dealer inventory, and a growing willingness to “experience” products virtually, rather than visit multiple showrooms, will require that the age-old template of build-to-stock will have to give way to a new retail experience for customers.

In 2016, anticipating the auto industry’s then planned transformation, a BMW board member had predicted that “the next 10 years are probably going to involve more change than we have seen in the last century”. That was before we had any inkling of Covid-19. Now, that transformation journey must be completed with much less cash, smarter investments, and in a complex new socio-political landscape.

Dr V Sumantran is the Chairman of Celeris Technologies and the author of Faster, Smarter, Greener: The Future of the Car and Urban Mobility, published by the MIT Press in 2017. This is Part 2 of a 5-part series.

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