Global auto industry faces strong headwinds in 2019

It was in December of 2017 when Volkmar Denner, the CEO of Bosch, warned of slow growth in the following year during the course of an interview to a local German newspaper. This, he said, would be a result of an imminent slowdown in China coupled with the changing landscape for combustion engines.

Denner’s words have proved prophetic with 2018 turning out to be a period of severe stress for an industry already reeling under the burden of an emissions scandal. It now faces the double whammy of WLTP (worldwide harmonised light-duty vehicle test procedure) as well as a political/social backlash on diesel cars.

Diesel in free fall

In western Europe, while the petrol-diesel drive mix (45:55) in percentage terms was stable from 2011 to 2015, the Volkswagen scandal changed the equation. Sales of diesel cars have seen a sharp decline in the last 12 to 18 months as the issue has become increasingly political and part of all election campaigns.

Diesel cars have been banned in many cities and, in the case of VW, the petrol-diesel mix shifted to nearly 60:40 by September 2018. WLTP, on the other hand, was introduced in September 2018 for all newly-registered Euro 6 vehicles. It was intended to measure a vehicle’s fuel consumption and emission values in a lab using a wider and more dynamic driving profile.

This will be followed by RDE (real driving emissions) for all models from September this year where nitrogen oxide (NOx) and carbon monoxide (CO) emissions would be tested under real road conditions. In RDE, vehicles would be driven on public roads attached with a portable measurement tool.

The industry managed to mitigate these short-term challenges by fast-tracking part supplies and tooling to adjust to the new test procedures, particularly in Europe. However, companies are now bracing themselves for significant long-term headwinds globally.

CO2 regulatory economics is set to become complex with the European Union taking the lead and proposing extremely stringent targets post-2020. This will be taken up in a host of other nations bound by the Paris accord. Most oil importing countries will be keen on cost savings and will, therefore, push OEMs into reducing consumption and opting for hybrid and electric vehicles.

Bernhard Mattes, President of the German Association of the Automotive Industry (VDA), is convinced that the EU’s expectations are highly unrealistic with the targets set not feasible, neither technically nor economically.

During a recent analysts call, Frank Witter, CFO of VW, said the consequences of not getting over the line would mean significant cost burdens from penalties. VW was already factoring these in its books, he added. Industry observers have estimated penalties of over $10 billion for European auto-makers.

CO2 reduction

OEMs are expected to reduce their fleet average of CO2 emissions from 130 grams per km in 2015 to 95 grams per km by 2021, clearly a tall order. To put this in perspective, BMW’s seventh generation 3 series (320d xDrive sedan) launched at the Paris Motor Show last year offers a larger and lighter car with similar power (190 ps) output compared to the previous generation.

Yet, its average emissions have only reduced from 140 gram to 120 gram per km. The only way for BMW to come closer to the fleet average target is to introduce more models that are plug-in hybrids, full hybrids or pure electric.

The company plans to launch a 3 series 330e plug-in hybrid (electric drive with gasoline engine) in July 2019 with CO2 emissions of 39 gram per km. Fuel consumption will be down from 5.8 litres to 1.7 l per 100 km. Even though the EU will count each of such cars as two in 2020, it remains to be seen how many will be sold in a short timespan to meet the 2021 fleet average target. The task becomes even more difficult as the share of diesel falls even while demand for SUVs rises and there are not enough gasoline or electric vehicles to compensate and help meet the 2021 targets. And to make matters worse, the EU proposes to reduce emissions by a further 15 per cent in 2025 and another 15 per cent by 2030.

China’s electrification push

China, on the other hand, is attempting to push compliance on similar lines but with a single path of electrification. Early indicators in the last few quarters suggest that the market is slowly adjusting towards this goal though the changeover will not be fast.

Industry observers believe that only 15 per cent of the vehicles produced in the EU will be pure electric by 2030 (from almost negligible levels today). The majority would remain combustion or hybrid powertrains, although this scenario might be different in China, which will lead the pack in EVs.

For OEMs, this massive change would mean high startup investments and the reality of living with lower margins in the EV space. They will have to continue this balancing act on their powertrain mix for some more years to come.

How are powertrain suppliers coping with these headwinds? There has been a whirlwind of reorganisation and merger-and-acquisition activity, which will intensify in 2019. Elmar Degenhart, CEO of Continental, said at the annual shareholder meeting last April that the drive system revolution towards clean air and sustainable and safe mobility had affected over half of the company’s powertrain revenues.

The Board of Continental had, in July 2018, approved a carve-out of the powertrain into a separate company with a new management team while giving the go-ahead for an IPO in the middle of this calendar. The new company will continue to focus on the existing gasoline and diesel business while adding new products for the changing landscape as well as a powertrain mix in the future.

Bosch was quick to make a reorganisation in 2017 by bringing all powertrains (present and future development) under one roof: Powertrain Solutions Division. Delphi Automotive had, by end-2017, split into Delphi Technologies focussed on traditional powertrain, and Aptiv on high voltage electronics and ADAS components. Tenneco acquired Federal Mogul in May 2018 that helped it reorganise its business on the lines of aftermarket and powertrain products.

Consolidation and value creation

To that extent, consolidation among Tier 2 suppliers has been an ongoing exercise for a couple of years now. Indian vendors have also been part of this exercise, a list that includes Amtek Auto, Bharat Forge, Mahindra CIE, JBM and others. They have bought out companies in Europe that focus on lightweight aluminum, magnesium and carbon fibre material know-how.

Indian suppliers are also climbing up the value chain moving from supply of only components to R&D based sub-systems that are needed to manage the country’s Bharat Stage VI emission norms that come into effect from April 2020.

Amit Kalyani, Executive Director of Bharat Forge, recently drove home the point that in BS VI cars, it is not just the engine and the emission system that changes but the entire drivetrain and powertrain. The company expects to see large growth in these new areas.

In addition, Bharat Forge has also invested in startups on both low voltage (with two-wheelers as focus) and high voltage products to meet the needs of cars and commercial vehicles. Indian subsidiaries and affiliates of global Tier 1 companies will now have to compete with their peers across the world to win orders, which can only come about through improvement in costs and quality while building economies of scale. According to ACMA (Automotive Component Manufacturers Association of India), the powertrain alone accounts for over 50 per cent of Indian suppliers’ output and exports. In FY18, they recorded a turnover of $51.5 billion with exports accounting for a fourth at $13.5 billion.

To grasp these global dynamics and strengthen the base for suppliers and OEMs alike, policy-makers in India must spell out a clear strategy and roadmap. This will provide the impetus to build a strong export-focussed supplier ecosystem. Additionally, issues on fuel efficiency standards, electric mobility, etc, need to be articulated better for a country that is on course to becoming the world’s third largest producer of cars.

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