Horacio Coutino, Multi-asset Strategist
Imminent tariffs from a nascent US administration
“And that's going to be the end of Michigan… If I am going to be President of the country, I’ll put a 100%, 200%, 2,000% tariff. They are not going to sell one car into the United States, because we’re not going to destroy our country… I will put a 100, 200, 300 (per cent tariff), I’m going to put the highest tariff in history, meaning I’m going to stop them from ever selling a car into the United States.” President-elect Donald Trump, referring to the possibility of Chinese Original Equipment Manufacturers (OEMs) manufacturing cars in Mexico and then selling them in the US, speaking to Bloomberg News Editor-in-Chief John Micklethwait, at an economic event at the Economic Club of Chicago, on 15th October.
Following the result of this month’s US election, investor attention will likely now be turning towards transatlantic trade flows. For the automotive industry, while manufacturers such as BMW and Mercedes operate bi-directionally, producing vehicles in both the US and Europe for their respective markets, others, including Porsche, Ferrari, and Aston Martin, rely entirely on European production.
Although potential modifications to existing tariffs remain subject to various pathways and timelines, the automotive industry retains a global character in terms of component sourcing, manufacturing, and sales. Consequently, any friction to trade generally presents a net negative impact on the industry.
Currently, the US levies a 2.5% tariff on finished vehicles imported from Europe, while Europe imposes a 10% tariff on US imports. Should the US opt to increase its tariff range by 7.5% to 17.5%, the potential impact on earnings before interest and taxes (EBIT) margins would vary across manufacturers. This impact is contingent on the ability of each company to pass on the increased tariff costs to consumers.
Based on current import/export dynamics, Volvo Cars appears most vulnerable to such changes, followed by Mercedes, Porsche, BMW, and VW. Luxury and premium OEMs face the most significant risk exposure. Specifically, Porsche's entire US sales volume is imported from Europe, representing 25% of its global sales. Similarly, Volvo Cars sources 88.9% of its US sales from Europe, accounting for 14.7% of its total sales.
For BMW and Mercedes, approximately 43.5% and 46.2% of their US sales, respectively, originate in Europe. These figures equate to 6.4% and 7.0% of their respective global volumes. Generally, both manufacturers produce mid-size and large SUVs within the US, while sedans, smaller SUVs, and battery electric vehicles (BEVs) are produced in Europe and Mexico.
In contrast to the aforementioned manufacturers, Volkswagen Group (VW) exhibits a lower sales exposure to potential US tariff increases. Only 3.5% of its global sales comprise US imports produced in Europe, primarily consisting of Porsche and Audi models. Furthermore, 37.6% of VW's US sales originate from Mexico. Similarly, for Stellantis, vehicles produced in Canada and Mexico for the US market represent 10.1% of group volumes. Consequently, any revisions to the United States-Mexico-Canada Agreement (USMCA) trade agreement could have significant implications for these companies.
Source: Factset
It is crucial to note that regardless of any concrete changes to tariffs, the mere presence of trade-related rhetoric following the election is anticipated to exert downward pressure on the market valuations of European OEMs. This underscores the sensitivity of the automotive sector to the broader geopolitical climate and the potential impact to investor sentiment.
Regulatory risk: emission standards and tax credit exposure
The Biden administration enacted policies that relaxed federal tailpipe emission standards and sought to limit the ability of individual states to impose stricter requirements. The US President possesses the authority to adjust federal emissions regulations and interpret aspects of the Inflation Reduction Act's (IRA) implementation, such as the treatment of leased vehicles, without Congressional approval. This introduces a degree of downside risk to existing forecasts for electric vehicle (EV) sales volumes within the US market.
Traditional automakers, such as Ford and GM, currently experience financial losses on EV production. Less stringent emissions rules could potentially mitigate these losses. However, the implications of potential auto tariffs for domestic OEMs are mixed. While import tariffs could diminish competition from China and Europe, both Ford and GM have manufacturing operations in Mexico, and the broader automotive supply chain relies significantly on Mexican production.
For EV-only manufacturers, relaxed federal emissions standards could limit the opportunity to generate revenue from regulatory credits, a crucial factor for companies like Rivian. Conversely, reduced regulatory pressure could also lead to decreased competition within the EV market.
It is important to consider the recent history of US vehicle emission standards. On 20th March, 2024, the US Environmental Protection Agency (EPA) issued a final ruling on new federal vehicle emissions standards, scheduled for phased implementation across model years 2027 through 2032. While these standards do not explicitly mandate a specific threshold for EV production, the EPA has projected various powertrain mix scenarios for OEMs to achieve compliance with greenhouse gas (GHG) emission targets. Notably, the performance-based nature of these standards grants manufacturers flexibility in selecting the technological mix that enables them to meet fleet-wide compliance.
EPA regulations have historically been subject to revisions under different administrations. During the previous administration of President-elect Trump, a rollback of US vehicle emission standards was implemented, resulting in annual increases of 1.5% through 2026, compared to the 5% increases stipulated in the preceding regulations. The EPA has indicated that, under those prior rules, the majority of automakers were unable to meet the 2012 standards without relying on the use of credits.
As of 1st November 2024, the US Department of Energy's website identifies over 40 EV models and a limited number of plug-in hybrid electric vehicle (PHEV) models that qualify for tax credits under the Inflation Reduction Act (IRA). Analyst estimates suggest that these eligible EV models constitute approximately 40% to 60% of US EV deliveries year-to-date in 2024. However, it is important to note that some individual purchasers of these vehicles may not qualify for the credits due to income limitations. Conversely, business EV purchases, including vehicles leased to consumers, are not subject to battery content or income restrictions, thereby expanding the range of vehicles eligible for credits.
In the PHEV segment, the platforms qualifying for IRA credits represent an estimated 25% to 45% of PHEV volumes year-to-date in 2024. For context, PHEVs comprised roughly 1% to 2% of total US vehicle sales in 2023.
Projecting the percentage of the market eligible for IRA credits in 2025 presents a challenge due to the interplay of increasingly stringent battery requirements and ongoing efforts by OEMs to adapt their supply chains to maximise credit eligibility. Furthermore, a significant portion of EVs currently benefit from 45X credits, which provide up to $45 per kilowatt-hour for batteries. This translates to a potential credit of approximately $2,700 per vehicle for a 60 kWh battery pack. Many EVs sold by 2025 will leverage some level of 45X support as domestic battery manufacturing expands.
A hypothetical repeal of the IRA would likely have a substantial impact on the majority of EV sales in 2025. Some vehicles would lose both the $7,500 consumer tax credit and embedded 45X battery support, while others would be solely affected by the loss of 45X support.
While a reduction in IRA credits would undoubtedly influence EV demand in the US, several factors remain supportive of long-term EV growth. These include global emissions regulations and policies, particularly in Europe and Canada, as well as economies of scale achieved through the development of globally adaptable EV architectures. These factors contribute to improved EV cost competitiveness and consumer choice over time.
OEMs exhibit varying degrees of exposure to IRA 45X credits for battery production and GHG emissions credits. Tesla, for example, anticipates exceeding $1 billion in revenue related to 45X credits in 2024, and has generated approximately $2.1 billion in regulatory credit revenue year-to-date, although not all of this is attributable to US emissions requirements. GM projected at its investor day approximately $800 million in 45X credit revenue in 2024 and anticipates generating $2,000 to $4,000 per EV in GHG credits, translating to roughly $600 million based on its projected wholesale volume of 200,000 EVs this year. In contrast, Ford does not currently derive significant benefits from 45X credits, but this is expected to change in 2025 as the company expands its joint venture battery operations.
US sales and inventory dynamics and the industry's path to recovery
The global automotive industry faces a complex landscape. While fundamental headwinds exist, including weaker demand among lower-income consumers, a slowdown in North American and European EV demand, and intensifying competition from Chinese manufacturers, several counterbalancing elements warrant consideration.
The current seasonally adjusted annualised rate (SAAR) for vehicle sales remains below its 10-year average of 16.07 million units, suggesting room for expansion. In September, light vehicles sales (SAAR) in the US in September were 15.07 million. This difference indicates the possibility of pent-up demand that could materialise as economic conditions ease further. The current seasonally adjusted annualised rate (SAAR) for light vehicle sales exceeds both the 3-year average (14.72 million units) and the 5-year average (14.92 million units). This indicates a sustained recovery in the automotive industry following the disruptions caused by the COVID-19 pandemic.
Furthermore, the year-over-year growth rates for light vehicle sales have rebounded from the negative territory observed in 2021 and 2022. This positive trend echoes the recovery patterns witnessed in the aftermath of the 2008 Global Financial Crisis (GFC). Following the GFC, light vehicle sales experienced a significant resurgence, climbing from approximately 10 million units in mid-2009 to over 15 million units by mid-2013. The current recovery trajectory suggests a similar potential for sustained growth in the automotive sector’s top line.
Source: US Bureau of Economic Analysis, Light Weight Vehicle Sales: Autos and Light Trucks, retrieved from FRED, 11th November, 2024.
While the recovery in light vehicle sales is encouraging, a deeper analysis of the US Auto Inventory/Sales Ratio reveals a more nuanced picture. The current ratio of 1.27x, while higher than the 3-year average of 0.89x, remains significantly below the 10-year average of 1.96x. This discrepancy highlights the persistent production challenges faced by automotive OEMs.
The 3-year average reflects the impact of the global semiconductor shortage, which severely disrupted the automotive supply chain. Although the industry has made strides in overcoming these disruptions, the current inventory-to-sales ratio suggests that production has not fully recovered to pre-pandemic levels.
Source: US Bureau of Economic Analysis, Auto Inventory/Sales Ratio, retrieved from FRED, 11th November, 2024.
This disparity between sales, which are approaching their 10-year average, and inventory levels, which remain significantly below their 10-year average, indicates that production has lagged behind demand. This imbalance can result in reduced product variety for consumers compared to previous years. Furthermore, it may contribute to sustained pricing pressures, as limited inventory can empower sellers to maintain higher prices.
The anticipated further easing of monetary policy is expected to provide a modest tailwind for the industry and for US consumer disposable income. Lower interest rates can stimulate auto financing, making vehicle purchases more accessible to consumers, which could positively influence both sales volumes and pricing.
Automobile affordability is significantly impacted by prevailing interest rates and vehicle prices. Currently, the average finance rate on a 60-month new car loan from commercial banks stands at 8.63%. This represents a substantial increase of 3.48 percentage points compared to February 2020, when the average rate was 5.15%.
Source: Board of Governors of the Federal Reserve System, retrieved from FRED, 11 November, 2024.
Furthermore, the average loan amount for a new vehicle has risen considerably, from $32,724 in March 2020 to $39,266 in June 2024. This surge in borrowing costs, coupled with higher vehicle prices, poses challenges to affordability for consumers.
Source: Board of Governors of the Federal Reserve System, retrieved from FRED, 11th November, 2024.
Interestingly, the average maturity of new car loans has remained relatively stable at 66 months over this period. This suggests that while consumers are financing more expensive vehicles at higher interest rates, they are not necessarily extending loan terms to mitigate the impact on monthly payments.
While the automotive industry is recovering, it also continues to grapple with supply-side constraints. A complete recovery will necessitate a more balanced alignment between production capacity and consumer demand.
Headwinds intensify for European automakers: different drivers of guidance downgrades
Since the end of Q2 2024, several European OEMs have revised their FY 2024 guidance downwards. Only Renault and Ferrari have refrained from issuing such warnings at this time. While these revisions suggest a more challenging industry environment, the reasons cited for the adjustments vary across OEMs.
Porsche, among the first to issue a warning in July, attributed its revised guidance to a supplier force majeure. BMW, while acknowledging a softening in the Chinese market, primarily attributed its warnings to a distinct company-specific supplier issue necessitating substantial provisions and leading to a stop-sale order on certain models. BMW stated that, absent this supplier disruption, a guidance revision would not have been warranted at that juncture. More recently, Aston Martin also cited supplier challenges as a key factor in its revised guidance, while similarly highlighting weaker consumer demand in China.
In contrast, Mercedes significantly reduced its FY24 expectations due to weak demand in China and other parts of Asia, coupled with more subdued demand for top-end vehicles. Volkswagen reported reduced demand across geographies for its VW brand, while Stellantis faces a company-specific destocking requirement in North America in addition to heightened competitive dynamics globally. Volvo Cars cited a deterioration in the macroeconomic environment, along with potential EU tariffs, as contributing factors to its revised retail sales estimates for the year.
It is plausible that further negative revisions may be necessary for those companies that have attributed their initial warnings to company-specific challenges rather than broader industry headwinds. Several factors have contributed to the sequential decline in industry profitability, including weaker volumes, softer pricing, and negative product mix.
It is clear that European OEMs face a particularly challenging environment. The deterioration in global industry forecasts, driven by intensified competition from Chinese automakers and a weakening demand for EVs, has exerted significant pressure on these companies.
Furthermore, European OEMs encounter distinct challenges in meeting their supply needs. Unlike their US counterparts, who benefit from the integrated North American supply chains facilitated by the USMCA trade agreement, European OEMs face greater complexities in sourcing components and raw materials. This vulnerability to supply chain disruptions further contributes to the subdued outlook for these companies.
How is software redefining the automotive industry?
The global automotive industry's future success hinges on mastering the synergy between vehicle platforms and power systems, encompassing both electric and hybrid technologies. This platform and power theme extends beyond the automotive realm to encompass industrial and technological infrastructure.
Platforms refers to the foundational hardware, such as electrical and electronic architecture and powertrains, which serve as common building blocks across vehicle models. Furthermore, the vehicles themselves transform into platforms for the sale of high-margin software and services. As automakers expand their connected vehicle fleets with shared software, a new ecosystem emerges, brimming with potential for innovative digital products, including those from third-party developers.
Power signifies the critical role of power efficiency in optimising the cost and range of electric and hybrid vehicles. It also encompasses the products employed to power hardware, spanning data centres, electrical grids, and EV chargers.
Enhanced software and services within the vehicle ecosystem offer automakers the opportunity to cultivate higher-margin revenue streams and foster stronger customer relationships.
While current market sentiment reflects an anticipated profit decline for traditional US automakers over the next 12 to 24 months, analysis suggests a more optimistic outlook. With the seasonally adjusted annual rate (SAAR) still below long-term averages and the potential for rate cuts to bolster the economy and auto industry, these stocks have the prospective to outperform by delivering relatively stable earnings before interest and taxes EBIT and free cash flow (FCF) over the same period. This stability, coupled with longer-term growth prospects tied to software and services, underpins this positive view. As connected vehicle fleets expand with shared software, the potential arises for this ecosystem to become a fertile ground for new digital products, including those developed by third-parties.
The significance of platforms is twofold. Firstly, hardware platforms underpinning vehicles are becoming increasingly software-defined, utilising common electrical and electronic architectures. This modularity enables global scalability and cross-model compatibility. Secondly, connected vehicles evolve into platforms for software and services, with automakers offering products like advanced driver-assistance systems (ADAS), insurance, and predictive maintenance. As connected vehicle fleets expand with shared software, the potential arises for this ecosystem to become a fertile ground for new digital products, including those developed by third parties.
Furthermore, power considerations are paramount. Optimising EV range necessitates a system-level approach to power efficiency. Future vehicles will increasingly utilise centralised compute platforms, consolidating the functionality of numerous electronic control units (ECUs) into a smaller number of more powerful units.
This trend is exemplified by Rivian's recent announcement regarding its redesigned R1 model. The updated vehicle incorporates only seven in-house ECUs, a significant reduction from the 17 ECUs present in the first-generation R1. This streamlined architecture contrasts sharply with the traditional industry practice of employing 30 to 40, or even over 100, ECUs.
This transition towards centralised computing offers several advantages, including improved efficiency, reduced complexity, and enhanced capabilities for advanced features such as autonomous driving and sophisticated infotainment systems. As these new features gain prominence and wider adoption, automotive OEMs are increasingly motivated to internalise the development and production of critical components, including ECUs, which were historically sourced from external suppliers. This strategic shift towards in-sourcing allows OEMs to exert greater control over key technologies, optimise performance, and potentially reduce costs in the long term.
Consequently, automotive tier 1 suppliers (companies that supply parts or systems directly to OEMs), electric and electronic component providers, and electronics manufacturing services (EMS) companies must adapt to these evolving trends. These suppliers must ensure their products seamlessly integrate at the system and platform levels. For automotive tier 1 suppliers, product leadership will be even more crucial for connected and electrified vehicles than for traditional vehicles.
What might an Auto OEM portfolio look like?
A strategically designed portfolio representing the automotive industry can be constructed using seven leading original equipment manufacturers (OEMs) listed in the US and European markets. These OEMs, namely Bayerische Motoren Werke AG (BMW), Ford Motor Company (Ford), General Motors Company (GM), Mercedes-Benz AG (Mercedes-Benz), Stellantis, Tesla, and Volkswagen AG (VW), collectively generated over USD 1.331 trillion in annual net sales as of Q3 2024.
While each OEM possesses a distinct geographic footprint in sales and production, the current market capitalization of these companies is heavily skewed towards Tesla. As of 14th November, 2024, Tesla constitutes 78.3% of a market-weighted portfolio comprising these seven OEMs, despite accounting for only 7.27% of the portfolio's total annual net sales.
To address this disproportionate influence, our analysis will utilise two distinct portfolios. The first, referred to as Global Autos, is a market-weighted portfolio that reflects investor sentiment and the dominant market influence of Tesla. The second, Detroit Three, consists of Stellantis, GM, and Ford, which represents 41.5% of Global Autos' annual net sales. This portfolio provides a more balanced perspective on the industry's dynamics and challenges.
This dual-portfolio approach will enable a comprehensive evaluation of the automotive industry, considering both investor expectations and the operational realities of major manufacturers.
Source: Factset
How have they performed this year?
So far this year the performance of Global Autos has been predominantly positive with only 2 of its 7 constituents showing significant gains, led by GM at 60.5% and Tesla at 40.9% as of 12th November. The underperforming stocks are Stellantis at -41.7%, BMW at -32.7% and VW at -24.4%. In contrast, the Detroit Three portfolio has yielded a YTD return of 9.1%, primarily driven by GM's strong performance.
Source: Factset
Accelerated recovery in profitability in the last 5 years
A quantitative analysis reveals a contrasting picture of earnings growth in the automotive sector. Over the past five years, both the Detroit Three and Global Autos portfolios have demonstrated substantial earnings per share (EPS) growth, significantly surpassing the performance of the S&P 500 and the Stoxx Europe 600.
The Detroit Three portfolio achieved a remarkable 127.6% accumulated EPS growth, translating to a CAGR of 17.9%. In comparison, the S&P 500 experienced a more modest growth of 42.5% (CAGR of 7.3%) during the same period.
It is important to acknowledge that the industry faced significant challenges due to supply chain disruptions in the aftermath of the pandemic. This is reflected in a pronounced earnings decline observed until the first quarter of 2022. However, it is noteworthy that EPS figures have subsequently rebounded and currently exceed pre-pandemic levels.
Source: Factset
The robust earnings growth in the automotive sector has translated into favourable capital returns for investors. Dividend per share (DPS) growth for both the Detroit Three and Global Autos portfolios has outperformed the broader market, as indicated by the S&P 500 and STOXX Europe 600 indices.
This trend is particularly important for the Detroit Three portfolio. Despite a significant decline in DPS throughout most of 2021, distributions rebounded strongly, surpassing pre-pandemic levels in 2023. Currently, DPS for the Detroit Three exceeds the levels observed five years ago by over 50%, reflecting a CAGR of 9.5% over this period.
This remarkable recovery and growth in dividend payouts underscore the financial strength and commitment to shareholder returns within the automotive industry.
Source: Factset
What is the risk-return profile of the Detroit Three and Global Autos?
A risk-adjusted analysis further accentuates GM’s impressive year-to-date performance. While Ford and Stellantis have underperformed this year, GM's strong returns have propelled the Detroit Three portfolio to a 1-year return-to-volatility ratio of 1.3x, surpassing the Global Autos portfolio's ratio of 0.8x.
However, the last 12 months have witnessed a widening divergence in risk-adjusted performance among the Detroit Three constituents. Ford, despite a current 1-year return-to-volatility ratio of 0.34x, experienced an average ratio of -0.17x over this period, indicating significant fluctuations. Stellantis, facing considerable headwinds, has seen its 1-year return-to-volatility ratio decline to -0.97x, a level unseen since April 2020 and notably lower than its 1-year average of 0.82x.
These pronounced swings in risk-adjusted returns underscore the sensitivity of investor sentiment to company-specific factors. While macroeconomic conditions and industry trends exert a broad influence, individual companies are uniquely susceptible to their own sets of challenges and opportunities. This dynamic highlights the importance of discerning company-specific catalysts and headwinds when evaluating investment performance within the automotive sector.
Source: Factset and Exante Research.
The prevailing competitive landscape and industry environment have impacted the valuations of automotive companies, albeit to varying degrees. An analysis of EV/EBITDA ratios reveals a nuanced picture across the constituents of the Detroit Three and Global Autos portfolios.
Ford and Stellantis currently exhibit EV/EBITDA ratios that exceed their respective 3-year averages of 10.0x and 1.2x. This suggests that despite challenges, these companies have maintained relatively robust valuations in the face of industry headwinds.
In contrast, GM presents a different scenario. Despite a strong YTD performance, its current EV/EBITDA ratio of 8.7x is slightly below its 3-year average. This seemingly counterintuitive observation can be attributed to GM's EBITDA growth, which has outpaced its EV appreciation.
Furthermore, both GM and Ford currently have EV/EBITDA ratios that are lower than their 5-year averages. This indicates that despite recent performance oscillations, the long-term valuations of these companies remain relatively attractive. For instance, GM’s is well-positioned for sustained financial performance in 2025. GM's commitment to cost optimization and the introduction of new models with enhanced profitability are expected to contribute to EBIT stability in 2025 relative to 2024. The company's expanding software and services business is projected to generate revenue growth at attractive margins, potentially contributing to y/o/y EBIT growth.
Additionally, strong automotive FCF generation reinforces GM's commitment to delivering shareholder value. The company's robust FCF is being actively deployed for capital returns to investors, further enhancing shareholder returns.
Summary
The automotive industry is highly complex, competitive and undergoing a significant transformation. Understanding the importance of the hardware that will be the underlying platform for new digital products and services is key as these companies transition to an ecosystem of services that can lead to multiple expansion.
The proposed tariffs by the President-elect represent a significant risk factor for the automotive industry, potentially disrupting the intricate and highly integrated North American supply chain. While major OEMs such as GM, Ford, Stellantis, and VW already operate production facilities in Mexico that adhere to the USMCA's rules of origin, the threatened tariffs fail to acknowledge the deep interdependencies within this regional network.
Imposing tariffs would likely have a disproportionate impact on companies that manufacture vehicles outside the USMCA region for sale in the US market. These companies could face increased costs and logistical challenges, potentially affecting their competitiveness and profitability.
Automotive original equipment manufacturers (OEMs) are confronted with a complex and evolving regulatory landscape that presents both challenges and opportunities. Emission standards, for instance, not only influence the delicate balance between internal combustion engine (ICE) and EV production but also impact vehicle availability within an already strained supply chain.
Moreover, recent media reports suggesting the potential elimination of the IRA’s 45X tax credits have raised concerns. Should these credits be revoked, EV-centric manufacturers like Tesla and Rivian, who are more reliant on such incentives to stimulate consumer demand, could experience significant adverse consequences.
However, it is important to acknowledge potential upsides within this regulatory landscape. Anticipated tax reductions may bolster consumer disposable income, thereby enhancing vehicle affordability in the near to medium term. This, in conjunction with an expected easing of monetary policy and lower financing costs, could generate a favourable demand environment for the automotive sector.
Recognizing the distinct drivers and outlooks for each OEM is crucial in the current market environment. Heightened investor sensitivity amplifies the impact of company-specific factors on stock performance, leading to increased divergence in returns. Therefore, a nuanced understanding of each OEM's unique circumstances, including its strategic positioning, operational efficiency, and financial performance, is essential for effective investment analysis.
While every effort has been made to verify the accuracy of this information, EXT Ltd. (hereafter known as “EXANTE”) cannot accept any responsibility or liability for reliance by any person on this publication or any of the information, opinions, or conclusions contained in this publication. The findings and views expressed in this publication do not necessarily reflect the views of EXANTE. Any action taken upon the information contained in this publication is strictly at your own risk. EXANTE will not be liable for any loss or damage in connection with this publication.
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