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COMMENTS

Asian Automakers Are In Pole Position For A Downturn In The Sector's Ratings Cycle


Asian Automakers Are In Pole Position For A Downturn In The Sector's Ratings Cycle

Auto companies in Asia could lead a cyclical downturn in ratings in the industry globally as competition, a market slowdown, and trade protectionism undermine their earnings, in S&P Global Ratings' opinion. We believe the global auto industry (including original equipment manufacturers and auto suppliers) is likely to have reached the peak of a positive credit cycle that began in 2010. In fact, negative rating actions on companies in the sector have begun to outnumber positive rating actions, and we expect industry earnings to remain under pressure for the next one to two years.

Sound Financial Health And Company Initiatives Continue To Support Ratings

We expect low adjusted debt, ongoing cost reductions, and solid product competitiveness to continue to broadly support ratings in the global auto industry. Key Asian automakers such as Toyota Motor Corp., Nissan Motor Co. Ltd., Honda Motor Co. Ltd., and Hyundai Motor Co. (including subsidiary Kia Motors Corp.) have sound financial health and effectively no debt. Automakers also continue to cut costs in pursuit of higher operating efficiencies. Cost reductions at Toyota Motor led to a ¥165 billion increase in earnings in fiscal 2017 (ending March 31, 2018). Meanwhile, companies are accelerating efforts to expand strategic tie-ups. The alliance between Renault S.A., Nissan, and Mitsubishi Motors Corp. has expanded to joint collaboration in aftersales activities and business developments, and the trio has also established a fund to invest in new technologies. Toyota Motor established a partnership with Suzuki Motor Corp. and Mazda Motor Corp. to collaborate broadly in research and development (R&D), production, and market development, while Honda collaborates with General Motors Co. in development of fuel cell technology and autonomous vehicles.

Pressure On Ratings Is Rising Amid A Market Slowdown

However, pressure on ratings on automakers has grown recently, exacerbated by market weakness and strong competition. Sales of light vehicles slipped 1.8% in the U.S. in 2017, the first such decline in eight years. Sales have been mostly flat in 2018. At the same time, growth in demand for vehicles in China is losing traction. Passenger vehicle sales in China rose only 0.6% year-over-year in the first three quarters of 2018 as tight liquidity and weak equity markets sapped consumer purchasing power.

As a result, we have taken more negative rating actions in the sector recently. Negative actions outnumbered positive actions in the third quarter of 2018, for the first time in six quarters. In October, strong pressure on earnings in the U.S. and China led to a downgrade of Hyundai. We also downgraded India's Tata Motors Ltd. in December following weaker earnings at its European subsidiary Jaguar Land Rover Automotive PLC (JLR) mainly due to soft sales of diesel vehicles and higher Chinese import duties. Such factors lead us to expect downward pressure on ratings on auto companies worldwide has continued in the fourth quarter of 2018.

Chart 1

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Negative Pressure Will Persist For Years

We expect auto companies' earnings to remain under pressure for the next one to two years. The U.S. auto market is likely to lose growth momentum as light vehicle sales decline in 2019 before stabilizing at 16.5 million-16.9 million units in 2020 and beyond. In China, we expect weak growth of 1%-2% in light vehicle sales in 2019 and 3%-4% in 2020 in the absence of government stimulus, which brings forward future demand rather than creating incremental demand, in our view. Pressure on earnings could also come from higher commodities prices; increasing R&D expenses; and weak performance in some emerging markets, such as Turkey, Argentina, and Russia. In addition, we see restructuring measures with the potential to erode earnings. For example, both Ford Motor Co. and General Motors Co. have announced companywide restructurings that include job cuts. Slower sales in the industry could also harm cash flow generation as proportions of working capital rise.

We also expect conditions for Asian automakers to get tougher in China, the world's largest auto market, amid a market slowdown. Tighter Chinese environmental regulations require automakers to increase sales of vehicles complying with a new energy vehicle mandate in 2019 and 2020 and to improve fuel efficiency of vehicles with internal combustion engines. In addition, we expect competition in China to intensify. Volkswagen AG and Toyota Motor plan to aggressively expand electric vehicle (EV) production capacity there. Nissan also intends to spend ¥1 trillion on more than 20 new EV models in China. Honda, too, expects to launch more than 20 EV models in China by 2025.

We expect ratings on auto companies to remain under pressure in the medium to long term. Automakers experiencing rapid technological developments such as electrification, autonomous driving systems, and connected cars must make significant capital expenditures, including for R&D, to maintain their competitiveness. In addition, the emergence of car-sharing mobility services reduces the visibility of future vehicle sales and the very viability of existing business models. Furthermore, tighter environmental regulations, as seen in Europe and China, are only likely to get stricter. Taken together, these risk factors lead us to conclude that a positive credit cycle triggered by solid sales growth in the global auto industry, and beginning in 2010, is likely to have reached a peak.

Trade Tensions Could Deal A Fatal Blow

Against a backdrop of increasing pressure on ratings, we believe further global trade protectionism could deliver the blow that sinks the positive credit trend for auto companies in Asia, particularly Japanese and Korean automakers. Trade negotiations are set to take place between the U.S. and Japan in January 2019. A rise in U.S. import duties on automobiles and auto components would inevitably hurt Japanese automakers' profitability. The trade dispute between the U.S. and China also threatens demand for vehicles in China that already looks weak. In our view, higher tariffs could accelerate a downturn in the rating trend for the auto sector, marking Asian automakers as frontrunners of the cyclical downturn.

Toyota Motor, Nissan, Honda, and Hyundai all sell more than 1 million units each in the U.S. and China. Vehicle sales in these two markets make up more than 30% of total unit sales globally. These markets' contributions to automakers' earnings should be larger given high proportions of sales of SUVs and luxury cars in each. In addition, we estimate ratios of local production to total unit sales in the U.S. are around 50% for Toyota Motor and Hyundai, around 60% for Nissan, and about 70% for Honda. Although we expect Honda to feel less impact, we believe higher tariffs inevitably further pressure its earnings. Transferring increased costs due to tariffs to sales prices could hurt demand for vehicles. Furthermore, raising production rates in the U.S. takes two to three years. Our recent downgrade of Hyundai has already factored in difficulties the company is likely to face in the U.S. and China. However, given Hyundai's weakened position, we believe trade tensions could have a relatively larger impact on it.

For Chinese automakers, we expect global trade protectionism to have limited direct impact, because import-export activities between China and the U.S. comprise a small part of their business operations. We understand they assemble most of their vehicles and auto parts locally. Rather, we see potential risk due to intense competition in China over the next year to 18 months, especially in light of slower growth of new car sales. However, we expect leading Chinese automakers with proprietary technology and design capabilities to outperform the market, reducing negative impact on ratings on these companies.

Tata Motors also faces potential disruption from Britain's decision to leave the European Union (Brexit), through JLR. JLR continues to face strong headwinds from a growing consumer preference for non-diesel vehicles, increasingly complex operating conditions, and exposure to event risks such as Brexit and emerging global trade wars. On Dec. 4, 2018, we downgraded Tata Motors because we expect the company's leverage to deteriorate over the next 12-18 months due to weaker-than-expected performance at JLR. The ratings remain on CreditWatch with negative implications to reflect the uncertainties for JLR from a fast approaching Brexit deadline. We intend to resolve the CreditWatch close to the Brexit outcome, likely within the next three months.

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This report does not constitute a rating action.

Primary Credit Analyst:Katsuyuki Nakai, Tokyo (81) 3-4550-8748;
katsuyuki.nakai@spglobal.com
Secondary Contacts:Machiko Amano, Tokyo (81) 3-4550-8659;
machiko.amano@spglobal.com
Leo L Hu, Hong Kong (852) 2533-3594;
leo.hu@spglobal.com
Minjib Kim, Hong Kong (852) 2533-3503;
Minjib.Kim@spglobal.com
Ashutosh Sharma, ACA, Singapore (65) 6239-6307;
ashutosh.sharma@spglobal.com

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