President Donald Trump's statement last week that the U.S. had agreed to a partial trade deal with China that would postpone a hike in certain tariffs on Chinese goods in exchange for China's increased purchases of American agricultural products, among other things, offered a bright spot in what has been a protracted dispute. As the countries resume trade talks, few industries will be keener for signs of progress than the automotive sector. Given China's role as a key link in the global supply chain--with the country accounting for roughly one-fifth of the world's manufacturing output--the tariff dispute between the White House and Beijing poses a stumbling block to automakers and suppliers. And, while there's as yet been little direct effect on creditworthiness for these companies, tariff-related disruption in the supply chain is raising manufacturing costs, slowing production, and, potentially, weighing on the quality of goods.
Earlier this year, financial market consensus was that the U.S. and China would come to an agreement--or at least a detente. But larger differences have emerged concerning each country's national interests. While recent negotiations will allay trade tensions for now, the question is whether both sides can put a long-term deal in place. The gap between the two sides with respect to structural issues, such as intellectual property, market access, and a level-playing field, remains wide, and prospects for a comprehensive deal will require difficult political concessions.
The rise of protectionism and national security as factors in trade policy suggest that existing supply chain configurations will need to be reassessed. Companies could look to hire workers and source materials within a regional bloc. While many auto companies already have, for example, regional manufacturing strategies, we think these efforts will intensify to minimize disruptions in trade.
The potential credit implications of a new regionalism are numerous. First off, compared to a less restricted global trade environment, input costs would become more expensive. In response, firms might need to relocate and incur the costs of reconfiguring their sourcing, manufacturing, and distribution footprint.
Additionally, there are higher-order effects that need to be considered. For instance, Beijing could put U.S. firms that operate in China at a disadvantage in order to favor local firms. (This can also work in the reverse. For example, the White House has already floated the idea of delisting Chinese companies from U.S. stock exchanges.) Also, escalating trade tensions can arouse nationalism and lead to falling demand for U.S. goods and services. Declining export demand can hurt overall GDP of the exporting county, and trade barriers limit the choice of imported goods. Consequently, industries that are more global in nature would be subject to greater credit stresses and will face challenges in repositioning their supply chains.
Current Economic Conditions
A U.S. slowdown
From a macroeconomic perspective, the dispute has raised uncertainty and added to signs that U.S. economic momentum is slowing. Of the 10 leading indicators of near-term economic growth that we look at in our U.S. Business Cycle Barometer, just three are positive, while four are neutral and three are negative. Last year, seven were positive and just three were neutral. Moreover, we now see the risk of a recession starting in the next 12 months at 30%-35%--more than twice what it was a year ago.
China's slowing growth
China is managing a slowdown at home as well as trade negotiations with the U.S., as growth remains under substantial pressure. The manufacturing sector, while less important now than it was a decade ago, still accounts for about 30% of GDP and is exerting a heavy drag on the economy. Manufacturing output growth has slowed below 5%, pulled down by autos, consumer goods, and electronics.
Policymakers appear content to allow growth to slow. For now, financial stability seems top of mind, and this means avoiding excessive stimulus. At the same time, the effects of policy easing have become weaker than in the past. Collateral damage from the trade-tech war is one reason, with soft investment, notwithstanding some moderate easing in financial conditions, reflecting weaker confidence about the outlook as it does financing constraints. We now expect growth of 6.2% this year and 5.8% in 2020.
Credit Implications For The Auto Industry
With its entrance into the World Trade Organization (WTO) in 2001, China has transformed from an emerging economy into a dominant global manufacturer. China is the largest maker of light vehicles in the world, accounting for 29% of production last year, according to market research from LMC Automotive. Nevertheless, the country has enjoyed a large trade surplus overall with the U.S. for decades.
To address this, President Trump imposed a 25% tariff on $250 billion of Chinese imports under Section 301 of the Trade Act of 1974. The levies were designed to counteract trade practices related to technology transfer and intellectual property protection deemed unfavorable to the U.S. On Sept. 1, the White House applied a 15% tariff on an additional $112.3 billion worth of goods, and could impose a 15% tariff on another $160.2 billion of Chinese imports on Dec. 15.
At this point, we see a limited effect on the ratings of U.S. automakers Ford (BBB/Negative/A-2) and General Motors (BBB/Stable/--) because of their lower reliance on exports and higher level of localized content relative to foreign automakers. Still, China is the largest growth market in the world, and Western manufacturers--particularly Ford and GM--could face challenges to growth due to tariff pressures and potential nationalism leading to anti-American sentiment. In China, we have already seen consumers adopt a wait-and-see attitude, delaying purchases.
For California-based Tesla (B-/Negative/--), tariffs will add significant incremental margin pressure. Incorporating Tesla's overseas transport costs and import tariffs, the company operates at a 55%-60% cost disadvantage compared with the same car produced in China. This will further intensify, and consumers might postpone or choose another brand subject to lower tariffs or no tariffs. Also, this increases the likelihood for higher import duties on certain components used in Tesla's products that are sourced from China, which will further pressure margins.
Tesla currently imports all of the cars it sells in China but plans to start making the Model 3, its top-selling vehicle, at its Shanghai Gigafactory. The company has had significant support from China for the factory, and we expect it to use local debt to fund the aggressive ramp-up of production to achieve its target of 500,000 vehicles globally in the 12 months ending June 30, 2020. As of March 31, the company had secured a credit line in China of about $522 million. We view this as roughly credit-neutral because Tesla plans to draw down on this facility gradually as construction gets up to speed given its agreement with local government to spend $2 billion in the next five years.
We expect tariff pressures to lessen once Tesla begins production at the Gigafactory. Also, we project lower costs from more simplified production processes and a local supply chain. Tesla's planned Model 3 lines in China are likely to be significantly cheaper per unit than related lines from its Fremont, Calif., and Gigafactory 1 plants. A recent announcement that Tesla cars could be exempted from a 10% purchase tax in China, something typically reserved for domestic makers of electric vehicles, is also a credit positive.
Tariffs could also affect German automakers' long-term profitability, as they have invested billions to expand U.S. factory production with the goal of exporting. It's too early to assume that they can pass on costs to consumers. An escalation in trade tensions could lead to the regionalization of supply chains; this would push up costs for the entire industry. More expensive auto parts would likely raise the price of new vehicles and weaken demand, with consumers more likely purchasing used cars. Also, escalating trade tensions and nationalism could intensify policies that favor local Chinese suppliers over foreign ones.
For example, China is the biggest single market for BMW (A+/Stable/A-1), accounting for about 26% of unit sales in 2018. Close to 30% of these sales were imports (and therefore consolidated in group figures), whereas the remainder was sold through BMW's Shenyang, China-based 50%-owned joint venture (JV) BMW Brilliance Automotive Ltd. The U.S. accounted for about 14% of BMW's car sales that same year. BMW announced in October of last year that it will spend €3.6 billion to increase its stake in the JV to 75% to help mitigate trade uncertainties. It expects to complete this by 2022, when the restrictions for passenger-car JVs are scheduled to be removed. BMW's U.S. production plant in Spartanburg is specialized in the BMW X series that it also exports to China. While BMW has localized its production of the X3 in China, we still expect the group to be among the original equipment manufacturers that would be affected by incremental tariffs between the U.S. and China as it continues to ship other X models from the U.S. to China and other countries.
For Germany-based Daimler (A/Negative/A-1), China is the biggest single market, as well, with 28% of its Mercedes Benz Car (MBC) sales last year. More than 70% of these sales were produced locally at facilities operated by Beijing Benz Automotive Co. Ltd., the joint venture it has with China-based BAIC Motor Corp. Ltd. (in which it holds a 10% stake). Moreover, the relationship between BAIC Motor Corp. Ltd. and Daimler further strengthened in July through the acquisition of 5% shares in Daimler by BAIC Motor's parent, Beijing Automotive Group Co. Ltd. (BAG). The U.S. accounted for 13% of MBC sales last year. Some of the SUVs (GLE, GLS) produced in Daimler's production facility in Tuscaloosa are exported to China and could be hit by incremental tariffs. However, Daimler is expanding its local production in China and will produce the first model of its EQ brand there by the end of this year.
The Effect On U.S. Auto Suppliers
We don't see tariffs on Chinese imports as having a materially adverse effect on U.S. Tier 1 auto suppliers. Typically, suppliers such as Adient (B+/Negative/--), Aptiv (BBB/Stable/--), BorgWarner (BBB+/Stable/A-2), Goodyear Tire (BB/Negative/--), and Tenneco (BB/Negative/--) manufacture in the country or region where they sell. But this isn't to say the tariffs are having no impact. Adient, the world's largest supplier of seating systems for light vehicles, estimates the total impact from the Section 301 tariffs, mainly due from importing electric motors, will be less than $20 million for this year. Aptiv, supplier of advanced safety and user experience solutions, believes the extra cost would be about $44 million in 2019. BorgWarner believes the cost of Chinese tariffs could be as much as $10 million a quarter.
It should be noted that these are large companies, with sales last year of $10.5 billion for BorgWarner, $14 billion for Aptiv, and more than $17 billion for Adient. While tariffs erode margins and increase credit risk, and we view the costs as incremental for most of the public auto suppliers we rate, they still need to keep their supply chains as efficient as possible. For instance, Aptiv has said it plans on moving some production out of China and into Korea once customer validation has been completed. The company is operating under the assumption that tariffs aren't going away. Moreover, even though many firms make where they sell, they may need to move their manufacturing footprint because their customers may need to resource their supply chains to a more favorable locale. The recent trend of declining U.S. imports of auto parts from China suggests that some suppliers are resourcing; moreover, they would likely be the Tier 1 players who are able to tap alternative sources more easily due to their larger size and geographic reach.
On the other hand, a number of smaller aftermarket auto suppliers--namely, Trico Group (B/Negative/--), APC Automotive (CCC/Negative/--), K&N Engineering (B-/Negative/--), Wheel Pros (B/Negative/--), GC Eos Buyer Inc. (B-/Negative), and Horizon Global (CCC/Developing/--) import a substantial percentage of their products from China. Tariffs on these companies can raise the cost of goods sold and put significant pressure on margins, andthese companies tend to have higher leverage and weaker cash flow than the larger Tier 1 suppliers.
While aftermarket suppliers are able to offset a part of the tariff impact by getting concessions from Chinese suppliers, the majority of the tariffs must be offset through rapid price increases or sourcing from other countries. Both of these alternatives take time, and large price increases to major retailers with strong bargaining power, such as Autozone and Advance Auto Parts, can be quite challenging. It's true, though, that these aftermarket suppliers dependent on China for their components are similarly situated, and over a longer time period will have to pass these higher costs to the consumer. A degree of differentiation then could be the extent of sourcing from China.
|Percentage Of Total Sales In 2018|
American Axle & Manufacturing Holdings Inc.
Cooper Tire & Rubber Co.
Cooper-Standard Holdings, Inc.
Delphi Technologies PLC
Ford Motor Co.
General Motors Co.
The Goodyear Tire & Rubber Co.
Harman International Industries Inc.
China has talked about placing U.S. companies on a blacklist if the countries are unable to come to terms. In June, the Chinese government conducted investigations on FedEx in relation to mishandling of packages. Later, the government fined Changan Ford (Ford's JV in China) roughly renminbi (RMB) 60 million ($8.4 million) for violating China's antimonopoly law. These incidents happened after the U.S. banned companies from doing business with Chinese multinational technology company Huawei. The Ministry of Commerce also said the government would formulate a list of "unreliable entities" that harm the interests of Chinese companies. There are no details on the list, but the government statement indicates potential escalation of retaliation, which may disadvantage U.S. companies that operate in China.
If this were to occur, American manufacturers' ability to participate in the largest car market in the world would be in jeopardy. If U.S. firms were squeezed out of China, a large source of their growth would be eliminated. Another case to consider is that, even if China wouldn't take drastic action because U.S. firms employ Chinese workers in well-managed, globally competitive manufacturing facilities, the ongoing uncertainty could trim investment in the country and dampen future growth. We believe Beijing would conduct any retaliatory moves against U.S. companies in a cautious manner, in consideration of the impact on foreign direct investment and local employment.
U.S. Tariffs On The Chinese Auto Industry
U.S. cars account for an estimated less than 1% of total vehicles sold annually in China, with more than 95% of vehicles manufactured locally. Therefore, the direct impact on the Chinese consumer appears quite limited. Moreover, the export of vehicles from China to the U.S. is negligible--less than 1% of total imports by volume (see chart 1).
Nevertheless, China is the second-biggest exporter of auto parts to the U.S., after Mexico. Based on the experience of a few leading auto suppliers in China, the effects of tariffs have been largely manageable. They've been able to pass through full costs, after difficult negotiations with auto manufacturers. They're also shifting some of the production out of China. For these companies, cost control is a top priority.
For smaller suppliers, 2018 was generally already a difficult year, and they've become more vulnerable. There have been media reports that a few local suppliers have gone bankrupt or are facing a liquidity crunch.
Chinese consumer confidence has been hurt by slowing economic growth in the country, which to a certain extent is affected by trade tensions. With household leverage at all-time highs, consumers are cutting discretionary spending. We believe this is one of the most important reasons for the decline in auto sales year to date. Another reason is the implementation of new emissions standards in July. Dealers tried to destock cars that didn't meet the standards in the first half of the year, and some consumers held back on purchases as they were unsure how long they could legitimately drive cars that don't meet the standards.
Meanwhile, trade tensions also increase investor uncertainty. Growth in China's fixed asset investment for the auto manufacturing industry decelerated to 3.5% last year, from 10.2% in 2017--and has slipped further to 1.8% in first seven months of this year. We believe some manufacturers and suppliers are cutting or delaying capital spending. For the manufacturers we rate, we haven't yet seen any significant scaling back of investment, given their position generally as industry leaders with low leverage, and they are targeting capacity expansion plans.
This report does not constitute a rating action.
|Primary Credit Analyst:||Lawrence Orlowski, CFA, New York (1) 212-438-7800;|
|Secondary Contacts:||David C Tesher, New York (1) 212-438-2618;|
|Beth Ann Bovino, New York (1) 212-438-1652;|
|Shaun Roache, Singapore (65) 6597-6137;|
|Nishit K Madlani, New York (1) 212-438-4070;|
|Claire Yuan, Hong Kong (852) 2533-3542;|
|Anna Stegert, Frankfurt (49) 69-33-999-128;|
|David Binns, CFA, New York (1) 212-438-3604;|
|Eve Seiltgens, Frankfurt (49) 69-33-999-124;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: firstname.lastname@example.org.