BMI View : The global auto supplier and equipment index has outperformed the global auto manufacturers index since the GFC. We believe the possible reasons for this include the greater flexibility of EU suppliers, the rise in the average age of US cars and trade protectionism. Two future developments, which may cause a reversal in fortunes in favour of OEMs are a pick up in the European auto market and the upcoming AEC in 2015.
We recently highlighted original equipment manufacturers' (OEMs') greater bargaining power versus auto suppliers ( see 'Illegal Cartels Highlight Low Supplier Power', October 1). However, we notice that this does not always translate into automakers' share prices outperforming. Indeed, when we chart the performance of the Bloomberg World Auto Manufacturers Index and Bloomberg World Auto Parts And Equipment Index over the past 10 years, we realise that both suppliers and automakers have their own periods of outperformance.
It is important to realise that while suppliers' margins on the parts they sell are usually lower than the margins which OEMs enjoy on their cars, there are other dynamics at play that determine the actual financial results of firms and ultimately their share price performance. The accompanying chart illustrates the outperformance of suppliers versus carmakers since the global financial crisis (GFC) of 2008-09. Below, we outline our arguments to try and explain this phenomenon and give our thoughts on changing industry trends, which may cause a reversal.
|Suppliers Outperforming Since The GFC|
|BW Auto Manufacturers & Parts And Equipment Indices (Top); Spread (Bottom)|
EU Suppliers More Nimble Than Carmakers
Vehicle sales in the European Union (EU) have been contracting since 2008 and sales declines in some markets intensified when the eurozone crisis hit the region in 2010. This has led to heavy losses for European carmakers in the past few years. Further compounding their problems is their inability to shed large proportions of their workforce, or expediently close underperforming factories, due to political pressure on some of these national carmakers to retain workers.
European suppliers, on the other hand, are less in the political limelight due to their smaller size and have therefore been able to rationalise their European operations faster. This has allowed them to be more nimble and re-orientate their businesses to find new growth opportunities in emerging markets (EMs) in Asia, Eastern Europe and Latin America, which are increasingly making up a bigger share of their sales ( see 'Suppliers Continue To Shift Strategic Focus', June 24).
Therefore, it is no surprise that the share prices of European suppliers have recovered much faster and stronger than their carmaker counterparts since the GFC.
Ageing US Fleet Makes Market Attractive For Suppliers
To be sure, the American consumer has deleveraged significantly since the financial crisis. However, the bumpy economic recovery has resulted in consumers holding on to their set of wheels longer and has also given rise to strong used car sales. Therefore, while new vehicle sales have been growing at a strong clip since 2009, the average age of the US vehicle fleet has recently climbed to an all-time high of 11.4 years.
In such an environment, suppliers would naturally perform better, as they are able to sell parts to OEMs for the production of new cars as well as sell replacement parts directly to the end consumers. As the vehicles on the road get older, it is reasonable to assume that spending on replacement parts has to rise to keep them in a roadworthy condition.
Trade Protectionism Puts Vehicle Imports At A Disadvantage
In recent years, trade protectionism, especially in EMs, has been on the rise. These countries have nascent auto industries, and in order to encourage automakers to produce domestically, they usually impose high tariffs on auto imports. While both auto parts and vehicle imports are taxed, parts are usually taxed at a lower rate. We believe this may be because governments realise that the lack of localisation in their domestic auto industries would still require local manufacturers to import components from overseas. A case in point is Vietnam, where the import tariff on completely built unit (CBU) imports from ASEAN will be 50% in 2014, but for car parts will only be 15-25%.
The upshot of this, in our opinion, is that suppliers would find it easier to export their parts to early emerging/frontier markets compared with automakers, whose exports may be priced out due to exorbitant tariffs.
Can Suppliers Continue Outperforming?
While there may definitely be other reasons for suppliers' share prices outperforming manufacturers in the past few years, the important question going forward is whether this trend will endure. We believe it is hard to tell at this point. However, we highlight two developments in the future, which may cause a reversal in fortunes.
Pick Up In The European Vehicle Market
Although BMI still maintains a bearish outlook on the European vehicle market, we expect the region to recover in the coming years. As sales in individual car markets begin to slow their rate of contraction, and eventually return to growth, on the back of pent-up demand, European carmakers' could begin to outperform suppliers.
Upcoming 2015 AEC Could Tilt The Scales In OEMs Favour
The upcoming ASEAN Economic Community (AEC) in 2015 will bring down trade tariffs within South East Asia (SEA) and by 2018 most, if not all, countries in SEA will cut their import tariffs to zero. This development may end up being a game changer for automakers as they concentrate their production in one or two hubs in the region and export their CBUs tariff-free to the rest of ASEAN.