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Credit FAQ: Q&A: COVID-19 And The Auto Industry--What’s Next?

(Editor's Note: Here, S&P Global Ratings discusses questions investors posed to our analysts at roundtables in Europe and the U.S. on May 18 and 19.)

As the economic shocks from the coronavirus pandemic continue to reverberate throughout the global economy, S&P Global Ratings forecasts light vehicle sales of 70 million-75 million in 2020—down 15%-20% from last year. That's now at the lower end of our base case scenario of March 23, which we have reviewed following our economists' downward revision to their global macroeconomic forecast on April 16. Our current U.S. sales forecast of 12.7 million vehicles represents a 25% decline and is markedly below our previous forecast of a 15%-20% decrease. For the March 23 base case scenario see "COVID-19 Will Batter Global Auto Sales And Credit Quality" and for the revised macroeconomic forecast see "COVID-19 Deals A Larger, Longer Hit To Global GDP."

Chart 1


We expect the slump will be particularly severe in the second quarter, with only a gradual recovery, assuming countries' measures to stem the outbreak are effective. While car markets will likely improve in 2021--we expect a rebound of 10% globally and 19% in the volume of U.S. car sales (see chart 1)--global sales will still be below levels seen in recent history. Sales in 2021 will approach only 2012-2013 levels, at least in North America and Europe. While sales rebounded after the previous 2008-2009 financial crisis, today's backdrop is different. The Chinese market, which was not significant at that time, is a force to contend with now. Although we do see evidence of a recovery in China, the growth rate is likely to be limited to the low single digits for 2021. As a result, the global auto industry faces suboptimal capacity utilization and therefore a rough road ahead. We believe it's unlikely automakers will register profitability and cash flow similar to those over the last five to six years.


What is the quarterly breakdown of your sales forecast for Europe?

For the region, we assume year-on-year declines of 20% in the first quarter and an unprecedented 65% in the second, and more or less flat growth for the third and fourth quarters. However, if the second quarter turns out to be weaker than we expect and we don't think a stronger second-half recovery will compensate for this, we could revise our forecast. At this stage, we don't believe that a weaker sales scenario in the first half than we expect now would necessarily mean that we would again review all the ratings on our auto issuers. We already expected the year to be very weak for the industry in terms of cash flow, and we anticipate a recovery in 2021. We cannot exclude that draconian cost cuts adopted during the lockdown in some cases could become permanent, creating some cushion to absorb headwinds in 2021.

We should note that we don't think the recovery in China is necessarily how other parts of the world would return to normal—in particular in Europe. That's because supply chains differ significantly by region, and European sales were expected to stagnate even before the pandemic hit. In short, we generally expect the recovery in Europe to be less dynamic than China's.

In your ratings analysis, are you looking past the current crisis as an exogenous event beyond the industry's control? If not, when could we see downgrades for companies that have negative outlooks?

It's important to stress that downgrades aren't a foregone conclusion for companies with a negative outlook. In fact, we could revise the outlooks to stable on many issuers if they appear likely to deal with the current crisis without a significant hit to their credit metrics. However, it's just as important to note that even before the coronavirus outbreak, the industry was facing a structural transformation that was bound to result in lower profitability and cash flow generation for a number of carmakers and suppliers.

We think the environment today will shed light on which companies are now better prepared for the challenges ahead and allow us to draw a clearer distinction between their strategies. Beyond purely looking at credit metrics, we therefore could reassess our view of the relative strength of individual business models, paving the way for a reassessment of business risk profiles.

In the near term, downgrades could happen for issuers with credit metrics already close to thresholds and for issues with funding constraints. In any case, rating actions will likely be determined by the credit story of each individual company, rather than by our assessment of the industry.

Is government stimulus supporting ratings on carmakers, and is there a benefit beyond the immediate boost to sales?

In Europe, we see initiatives in individual countries, which we deem helpful but not game changing. The European Commission indicated that it wants to harness stimulus to promote sustainability. This could mean that subsidies may help sales but, given the likely focus on low emission vehicles, the contribution to margins would likely be lower than for internal combustion engines, accelerating the margin dilution we associate with the transition to electrification.

Furthermore, the Chinese finance ministry in April said it would reduce subsidies for electric vehicles (EVs) in stages, rather than scrapping the subsidies and tax exemptions altogether by the end of 2020 as planned. It will start from a 10% cut in 2020 to a 30% reduction in 2022. The subsidies will apply only to cars priced at less than 300,000 yuan, meaning that many EVs produced by foreign manufacturers will not qualify. In our view, despite near-term actions, government incentives to promote EVs will likely continue to shrink, reducing their influence on consumer choices.

Beyond lifting sales, a main benefit of government support involves injecting liquidity into the markets or extending guarantees on new debt issues, thus reducing refinancing risk for issuers. For many suppliers, this is critical as they look to tap working capital to restart production.

Funding support--as we observed in the case of the French government with Renault (BB+/Negative), for example—can be effective in reducing near-term downside to the ratings. That said, we believe liquidity support has the greatest effect for companies at the lower end of the ratings spectrum, especially in the 'B' category, given that liquidity considerations are key for business continuity.

However, even where government support bolsters near-term liquidity, our expectations for the longer-term operating performance and credit metrics of borrowers remains key to possible rating changes. We think the crisis will reveal even more sharply the quality of companies' competitive positioning, cost management, and financial strength, which will be important rating drivers beyond liquidity.

Would you consider carmakers benefiting from state support as government-related entities and rate them as such?

We have had cases of government support to carmakers in previous crises but never considered them as government-related entities (GREs). In most cases, the rationale for government intervention has little to do with safeguarding automakers' creditworthiness and more with avoiding or lessening socially costly restructuring. We see a high likelihood that governments will consider extending extraordinary support to automakers in exchange for commitments to invest and produce in the domestic market to protect jobs. However, although ensuring the mobility of businesses and consumers is critical to an economy, we believe the importance of individual automakers is limited to governments. That's because a potential default of any carmaker would not necessarily impede mobility. Consumers would still have access to a large variety of competitors' offering products and services. Furthermore, we believe any support for the industry would be a targeted, one-time intervention to help companies through this period, not as a way to build permanent strategic ties between governments and automakers. The auto industry is global and highly competitive, and we expect management teams will continue make decisions purely based on commercial considerations, including regarding capital allocation. Also, in response to the pandemic, some interventionist governments have declared the capacity and willingness to support all of their countries' manufacturing activities and not specifically the auto industry. As a result, we see little room to consider automakers as GREs for the purposes of our ratings analysis at this point.

An exception to this is China, where we consider certain automakers as GREs, notably Beijing Automotive Group, China FAW Group, and Dongfeng Motor Group, and where the issuer credit ratings include up to four notches of support from stand-alone credit ratings. The GRE status underpins solid banking relationships and favorable treatment in terms of project approvals and land acquisitions. Plus, during the pandemic, GREs successfully lobbied local governments to help speed up the resumption of production of their auto suppliers. However, we view these GREs to be highly dependent on their joint ventures (JVs) with international partners, which are not GREs, in terms of R&D and the continuous rollout of competitive products. These JVs are the main profit drivers of the GREs. Accordingly, we have seen companies like Beijing Automotive Group trying to deepen the tie with its key international partner Daimler by acquiring 5% of the German automaker's shares. We also observe that none of these companies have succeeded in building a significant footprint outside their domestic market.

How do you factor the quality of managements into ratings? What actions can companies take that will make a difference in the near term?

We believe management expertise was already well reflected in our ratings before the pandemic. With specific reference to Europe, it is illustrative to look back to the management of the transition to the Worldwide Harmonized Light Vehicle Test Procedure (WLTP), which some auto producers managed better than others. However, this is just one example of the many disruptions the industry has had to face in recent years. Other more recent ones include the management of new product cycles in connection with their electrification roadmap and their CO2 obligations in Europe from 2020. Some producers had already lined up the bulk of new launches in late 2019, which somewhat lessens the impact of lost volumes on revenues with positive mix effects. Others that have trailed in updating their model fleets could experience pandemic-linked delays, which could cause them to fall further behind and lose market share. In terms of management quality, the current difficulty for Nissan is a case in point. The company's weaker earnings and damaged brand equity is as a result of pursuing an aggressive growth strategy at the expense of product competitiveness, which did not work. This lead to a costly cut in capacity and end to unprofitable models. Similarly, the long-standing alliance between Renault and Nissan failed to produce value sufficient to cover the performance weakness linked to management and governance factors.

We think the pandemic and its aftershocks will bring the quality of management into sharper focus not only because of its extraordinary challenges but also because of possible new opportunities. These include achieving a more efficient organization of the labor force and better capital allocation and stronger supply chain. For example, Toyota Motor has been relatively early in resuming factory operations in many regions. This reflects, in our view, the company's strong supply chain management. Based on past experience such as large earthquakes in Japan and floods in Thailand, the company in our view has developed more effective management to oversee potential risks in its broad supply chain.

In North America, we will evaluate the operational efficiency of management teams based on their willingness and ability to cut capacity because factory utilization is unlikely to approach historical levels of 80% at least until 2023. Many issuers have taken on more debt to bolster short-term liquidity. Therefore, managing cash flow to offset the drag from weaker operations and higher interest expenses is now key. This involves, among other things, looking at how companies focus spending on projects that are absolutely critical to their long-term competitiveness or invest in projects that come with an increasingly uncertain economic return.

Given that many credit metrics are weak for the ratings, how much will you focus on them in deciding on downgrades and how much on relative performance?

Even before the pandemic, credit trends were weakening for the global auto industry because of lower profitability and weaker cash flow, so many carmakers and suppliers entered this downturn in a fairly weak position. That said, some companies were more effective at flexing their cost base, and we expect them to emerge from the crisis more quickly and with relatively better generation of free cash flow. On another front, some companies will undoubtedly try to address their weaknesses by pursuing partnerships or full mergers.

This explains, for example, why we kept the 'BB+' issuer credit rating for Fiat Chrysler on CreditWatch with positive implications during this turbulent time. We continue to believe the planned merger with Peugeot has the potential for cost savings that go beyond what was initially prudently shared with the market, and that the entity born from the merger will be a relevant player in the world's increasingly regionalized car market.

Although cash flow adequacy metrics in 2020 will be significantly weak for the entire sector, our expectations for 2021 and 2022 will be key in our rating decisions. This requires us to have a good handle on what will happen to the market: A difficult task, given the uncertainty surrounding the pandemic and its effect on demand. Even in 2021, it is highly likely that profitability and cash flow adequacy metrics for the sector overall will be weaker than 2019 due to capacity utilization that is less than optimal and a higher debt load. In the end, ratings are relative so peer comparisons will be key. At any time, our ratings reflect a fundamental forward-looking view of credit quality, regardless of where we are in an economic or credit cycle--or crisis such as the current one.

Are you following an industrywide approach in taking rating actions, or do you make distinctions between individual carmakers and suppliers?

In taking rating actions, we are as issuer-specific as possible—and we have prioritized those cases where we believed headroom to absorb the current shock was most limited. That said, our economists' forecasts inform our industry expectations, even as we try to differentiate among issuers in terms of preparedness. For some, the current crisis might actually be a catalyst for them to accelerate strategic changes.

About the rating actions we've taken so far, the relative positions of carmakers and suppliers entering this period helps explain the negative outlooks on some versus the downgrades or CreditWatch placements for others. In fact, we may eventually revise the outlooks on some comparatively well-prepared issuers to stable and affirm their current ratings, if the market recovers as we expect from the second half of 2020 and beyond.

How have you factored the risk of supply chain disruption into your ratings? Do you see a need for automakers to support their suppliers?

Supply chain disruption is a key risk, and all manufacturers are monitoring the situation carefully. However, we think demand remains the most important risk as the recovery starts. Carmakers will be hard pressed to avoid any buildup of excess inventory of vehicles or parts.

The greatest risk of default for suppliers is usually when they restart production, because they often lack the funding to fully prefinance working capital requirements. There could be also cases where suppliers' capital structure becomes unsustainable, particularly if the recovery is weaker than expected. We thus expect producers to keep their suppliers afloat in all regions.

Keeping smaller auto suppliers solvent is critical for automakers in North America as they try to restart factories and generate cash from sales of large pickup trucks, crossovers, and SUVs. We expect GM and Ford to offer lender programs where a supplier gets an earlier payment from lenders for the full invoice, after paying a financing fee. In Europe, we expect some carmakers to put in place similar measures, possibly at a smaller scale, because suppliers might be more able to tap into a variety of publicly supported lending programs.

While a resurgence of U.S.-China trade tensions increases supply chain risk in the current situation, auto manufacturers generally follow a regional strategy--for example, those in North America source parts from North America--thus limiting the downside risk, and larger Tier 1 auto suppliers follow a similar strategy. The risk of disruption is higher at Tier 2 and Tier 3 suppliers, which often depend heavily on sourcing from China. Moreover, some of these companies are owned by private-equity firms and are therefore highly leveraged, leaving less room to cope with any major disruptions.

Even before the pandemic, some auto suppliers were planning to diversify their sourcing away from China, and we believe the crisis will intensify their efforts in this respect.

Related Research

  • COVID-19 Deals A Larger, Longer Hit To Global GDP, April 16, 2020
  • COVID-19 Will Batter Global Auto Sales And Credit Quality, March 23, 2020
  • Planned Savings Won’t Shelter Renault From Headwinds, June 3, 2020

This report does not constitute a rating action.

Primary Credit Analysts:Vittoria Ferraris, Milan (39) 02-72111-207;
Margaux Pery, Paris (33)1-4420-7335;
Claire Yuan, Hong Kong (852) 2533-3542;
Lukas Paul, Frankfurt + 49 693 399 9132;
Nishit K Madlani, New York (1) 212-438-4070;
Lawrence Orlowski, CFA, New York (1) 212-438-7800;
Katsuyuki Nakai, Tokyo (81) 3-4550-8748;

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