- Based on China alone a substantial decline in automotive is justified. As detailed below, exposure varies across OEMs and Tier Is. There is no single, simple bottom line for investors.
- Output is recovering in China, but coronavirus countermeasures have already cost the Chinese industry – both car companies and suppliers – at least 4 weeks in 2020Q1 output and sales.
- With China accounting for 30% of global automotive production and global sales, this 1/3 drop in 2020Q1 is a 10% hit to top-line revenue for global OEMs and Tier Is.
- Inventories delay the impact on North America until mid-March, when parts shipments will fail to arrive. Korea has already been hit, Japan is next.
- Uncertainty will remain high until Hubei-based plants restart March 11. These include Honda, Nissan, Renault, GM and PSA, and many global suppliers. And now there's Korea, Italy and Japan.
Whether or not Covid-19 goes global is driving overall market volatility, and auto stocks are down accordingly. However, there has already been an impact on global auto OEMs and Tier I's, so some decline is justified. Here I provide conservative estimates of the financial losses the industry has already incurred, based on what has already happened in China. Of course if quarantines extend to auto production regions elsewhere (Daegu in Korea and northern Italy), we could see comparable impacts emerge elsewhere.
In China, production stopped January 23rd, as the week-long Chinese (lunar) New Year holiday began on January 24th. Historically this holiday has seen 100 million Chinese migrants return from cities to visit their natal villages. Fortunately, that meant firms built up inventories going into the holiday. Unfortunately, because most of those infected had no or mild symptoms, there was no immediate quarantine. By the time the initial Wuhan lockdown began on January 23rd, perhaps 100,000 people had already left the city. Today it and the entire surrounding province of Hubei remains in lock-down, affecting 60 million people, including those elsewhere in China who cannot return home. Other parts of the country have regained a semblance of normalcy. The news in China has shifted from reporting new cases to reporting cured cases, and some automotive parts shipments are now reaching Europe. However for automotive, Hubei is part of the greater Yangtze River Delta, with 17 assembly plants (out of the 100+ in China as a whole) and over 400 supplier plants. To quote Toyota (Source: Automotive News, Feb 26):
some plants in the epicenter of the virus outbreak remain unable to produce and transport goods, while some plants remain closed under orders by regional authorities.
China is the largest economy in the world. Reflecting that, its domestic vehicle market, at 28 million units in CY2018, is one-third larger than either the North American or the European market (each at 21 million units; OICA data). Overall it accounts for 30% of the global industry. For the auto industry what happens in China matters. A lot.
Only this past weekend did photos from China show people returning to the streets and in subways. Nevertheless, Hubei remains on lockdown. The most recent statements from Honda indicate their plants will remain closed through March 11th (source: Automotive News China). However, throughout the major eastern regions of China, those finally able to return from their extended holiday face 2 weeks of quarantine. So plants won't even be able to staff for normal operations until the end of the first week of March, and it will take 2-3 weeks for output to normalize. For example, while Toyota's 4 assembly plants began reopening on February 17th, they are running only 1 of the normal 2 shifts, and not always for a full day (source: 朝日新聞ネット).
That's just as well, because sales were down 19% in January and 92% in the first two weeks of February. Dealers don't need additional inventory, and sales will remain depressed. Part will be the anticipated continuation of 20 months of decline (presuming February will be a down month, duh). The Chinese Association of Automotive Manufacturing (CAAM) had already predicted a 5% decline for CY2020 prior to the coronavirus outbreak. But it's also that the small business owners who comprise the core of the market have now lost 5 weeks of income, which will put many out of business. Most have little or no access to formal credit markets, so government monetary easing will do nothing for them. By the end of 2020, the industry will have seen 29 months of falling sales.
The New Years Effect: The Good Side
From the standpoint of epidemiology, the New Years timing was a worst-case scenario. From the perspective of the auto industry, it was a best-case scenario. Why? - because firms build up inventory in advance of the holidays, as over New Years assembly operations shut down across the automotive industry. For producers away from the epicenter in Wuhan, production interruptions will be short-lived and random, as with the "3/11" (March 11, 2011) earthquake and tsunami in northeastern Japan. Then, shortages of a single pigment made meant that certain black paints used in Europe ran out. It was similar with damage to the Tohoku plant of Renesas (OTCPK:OTCPK:RNECF). Certain options were unavailable, at Toyota and others, until a replacement plant in Malaysia started deliveries.
The impact on sales was trivial: dealerships hold inventories, and could steer customers towards other models, trim packages and colors. Furthermore, over the last 10 years not just the Japanese but the industry in general have improved their visibility into their "just-in-time" supply chains, from materials suppliers to 3rd- and 2nd-tier suppliers. They have used that knowledge to identify vulnerabilities and develop alternate sources and backup inventories. Lean is good, but you do want fat strategically located. (Unfortunately, while the auto industry can do that, all I manage is a spare tire.)
Hubei: The Bad Side
A short-run interruption, particularly to one well upstream in the supply chain, may thus never be visible to new car purchasers. OEMs, however, will be plagued with inefficiency, and extra costs to overcome bottlenecks. That will be apparent in China. The Hubei lockdown is now over 4 weeks old, and does not affect just a handful of suppliers.
By chance, as an academic economist in my first year of retirement, I have a research project underway on the geography of the Chinese auto industry. Using 2018 data, Hubei accounted for 17 out of 104 final assembly plants, more than any other single province. Most prominent is Honda (NYSE:HMC), whose 3 assembly plants are the sole production sites for their best-selling CR-V and Civic (at over 200,000 per year, they have been a large and profitable success). In addition the province is home to plants of GM (NYSE: GM), PSA (Peugeot, OTCPK:OTCPK:PEUGF), Renault (OTC:OTCPK:RNSDF) and Nissan (OTCPK:OTCPK:NSANY). While plants in the rest of China are gradually resuming operations - the photo above should indicate that phrasing may hide more than it reveals! - those in Hubei are currently scheduled to reopen only from March 11th, six weeks beyond their original post-New Years target. Honda notes that while they expect employees to return on the 11th, it will be 3 days before any production actually resumes (source: 自動車ニュース＆コラム2020年2月21-23日号). [A globalization aside: with the exception of one low-volume variant, the 10th generation Accord is made in Thailand and Guangzhou China, and Marysville Ohio but not in Japan.]
Hubei however is not just a locus of final assembly. It is also integral to the lower Yangtze automotive production network that accounts for half of all Chinese vehicle output. As part of an academic research project, I have so far compiled data on the location of 6,300 electrical, drivetrain and chassis suppliers in China. [Yes, I read Chinese. And Japanese and German.] Of these, 373 or 6% were located in Hubei, and the nature of my data mean that this is an underestimate. Now with 17 assembly plants, some of this is expected. Thus I deliberately left out seating plants from the above total. Why? - in China as elsewhere, "just-in-time" production means these only supply nearby assembly plants. Whether they operate or not doesn't affect the auto industry elsewhere.
The key issue is that not all the plants focus on customers in Hubei; some export to Asia, Europe and North America. Examples include major global suppliers such as Bosch (privately held) and Magna (MGA). These (alongside Denso) are the 3 largest global Tier I's. No individual factory is large enough to matter for their overall profits. But lack a seat recliner bracket (one of Bosch's Hubei products), and you as a Tier I seating supplier aren't shipping seats, and your customer's assembly plant shuts down. Supply changes are complex, and a month-plus stoppage in a key production center will with certainty have global ramifications. [I have fought off my impulse as an unreformed academic to provide a detail-laden list. Rest assured: these aren't two anecdotes, but two examples from a large dataset. Valeo, Dana, Cummins, Xiangyang (bearings), the list of significant players is long.]
China in Global Context
Few motor vehicles are exported from China. In 2019 the US only imported 68,573 cars and light trucks, all made at the plants of global OEMs and so their origin is unnoticed by most consumers. European import levels were similar. In contrast exports from the US significant, totaling 192,210 cars and light trucks, such as the BMW (OTCPK:BMWYY) Honda Motor Co., Ltd. (HMC) Stock Analysis & NewsX-series models for which all global production is in South Carolina. (US Department of Commerce data). Car dealers in the US and Europe won't be affected, but the February hiatus will knock 10,000 or so units off of exports. Overall the impact on vehicle sales and production outside of China is too small to concern investors, absent any future parts shortages.
Components are a very different story. The US exported $2.5 billion in automotive parts to China in 2019. One example is Gentex's (NASDAQ:GNTX) autodimming mirrors, found on high-end vehicles globally, all of which are made in Zeeland, Michigan. In contrast, we imported $15.6 billion in parts from China. Now much of that (say, 50%) is for the aftermarket, feeding into the sales of Advance Auto Parts (AAP), Autozone (AZO) and O'Reilly (NASDAQ:ORLY). Their business models rely upon carrying frequently used parts locally. In the aggregate they have a lot of inventory, so we'll hear of service shops having to reschedule a brake job or oil change until they can get a part shipped in from some other store. Not a big financial hit, since all three will be in the same boat. Or rather, the same boat will have left all three stranded. (Er, something like that, don't look to economists for fine prose.)
But then there are those printed circuit boards that lie behind the buttons on the armrests of doors, the gearshifts on consoles, and those for sunroofs and the climate control system. Those come from small suppliers, who depend upon resin suppliers, and guess what? Apple (or rather, Foxconn) can pay double without blinking an eye to see that their vendors get dibs on inventory. Circuit boards are their lifeblood. A Tier III auto supplier has little leeway to pay extra. It will be Webasto (sunroofs) or some similar supplier that will find itself unable to ship product.
Again, in the auto industry materials and components are stockpiled in advance of the Chinese New Year. While light-weight parts can be shipped via airfreight, bulk items move on ships. At the fast end, those take 3-4 weeks (source: Transit Times from Shanghai), from the loading of a container at a Chinese factory to its unloading at a firm in the US Midwestern "auto alley" or the EU French-German-Czech-Polish "auto corridor." But plants don't necessarily ship containers daily, and other delays mean the norm is about 6 weeks. In addition, ports in China have been shut, and it will take at least 2 weeks for them to start regular operations. (At least automotive doesn't need refrigeration. Produce containers are going to have to be emptied of rotting contents, and thoroughly cleaned, which no one is set up to do.)
That means that, in the normal course of events, post-Chinese New Year production would not make it to customers in the US until the first two weeks of March. Furthermore, just-in-time logic means that global suppliers have plants everywhere that their OEM customers have operations - Europe, Southeast Asia, Japan/Korea, North America, Brazil. What happens in the regions adjacent to China should thus give a foretaste of what will happen in Europe and North America at the end of March.
Disconcertingly, Korea - with ports within a day's sail of China - saw frequent interruptions from mid-February, driven by shortages of wire harnesses. This affected all producers there, including Hyundai/Kia (OTCPK:OTCPK:HYMLF) and GM's Daewoo plants. That's partly driven by the aggressive move into production in China by Kyungshin, its key wire harness maker. It is however only one of some 170 Korean Tier I's and Tier II's to set up in northern China, with its good logistics into Korean ports (Automotive News Feb 13). Japan is only starting to see an impact. Toyota, Nissan and Honda source their wire harnesses coming from the Philippines, not China, but Nissan Kyushu closed for 3 days and planned 4 days of short hours (sources: 日経新聞・電子版, 自動車ニュース＆コラム and author visits to wire harness manufacturers). Toyota has announced that they may have to curtail operations from March 9th, driven by the inability to ship, which also means that some of their suppliers have yet to resume production because they can't get parts. The key word is "curtail" - not stop. Even at Hyundai's plant in Ulsan, where today (Feb 28, Nikkei) a worker was found to have Covid-19, only the assembly line where he worked was shut down. The other 4 lines in the huge complex continue to operate, as key suppliers have increased production outside of China and as at least some deliveries from China have resumed.
With the exception of a short-term issue at a Fiat plant in Serbia, North America / Europe. However, Denso has just announced that their car audio operation in Spain will stop March 16th (Automotive News). That is consistent with the above timeline. Problems based further up in the supply chain (the production of precursors for plastics) may not appear until April. Absent direct effects from quarantines, as in China, the story so far is one of interruptions. That will change if Hubei cannot resume production as scheduled in mid-March, and the same will be true of Europe if northern Italy is quarantined.
What does all this mean for revenue and profits? While most plants are open - VW has 14 automotive assembly plants in China, and the last 6 were scheduled to reopen February 24 - production will be limited until operations normalize in Hubei. Nikkei XTech details major Japanese operations in China, across several industries, consistent with this picture of factories being reopened but operating at half capacity. Currently plants there will be allowed to reopen in the second week of March, but it will take several days to get underway. The effective resumption of operations thus will not be until the 3rd week of March, by which time employees who have returned from the provinces will be out of quarantine. But not all are returning. They have the understandable fear that Wuhan will be bad for their health, where many live in dormitories, and most must commute in crowded buses and subways, and eat with others in factory break rooms. In addition, firms didn't pay workers before holidays. Will a small supplier actually be able to pay them? Even if there are no further quarantines, firms will be understaffed and will only be able to work out of inventories of parts from before the New Years. March is mostly a lost cause, and output reduced in April.
First, even a conservative back-of-the-envelope calculation shows that this is not trivial. China accounts for 30% of global automotive sales for OEMs and Tier I suppliers. China's strong market, which only slowed in 2018, meant that profits have been higher, so that 30% in sales generated 40% of profits. Hence from the start of the New Years holiday through Friday 21 February, the industry has lost 4 full weeks of both output and sales (again, with dealerships closed throughout most of the country, sales in the first 2 weeks of February were down 92%). That is thus 1/3rd of 2020Q1 output and sales. With China 30% of the global sales, that's a 10% drop in global revenue, and (because automotive fixed costs are high), profits will decline by 15%-20%.
That is a conservative estimate because it only reflects what has already happened. Sales, however, will not recover in March. My own (off-the-record) conversations this week indicate that streets in Chinese cities remain unpopulated; the Shanghai high commuting report shows mostly green (here) while videos show subways largely empty (here, matched by data here). More important, again as noted earlier, small businesses have now lost a 5 weeks revenue: for all intents and purposes China is in a steep recession. Sales will remain down 75% through March, and if things go well, only recover to 50% in April. They were already down 19% in January. So let's average January, February and March: (19% + 92% + 75%)/3 = 62% decline for 2020Q1. This more realistic number means the hit to global sales 30%*62% = 19%. One in five dollars of global revenue isn't going to be there.
Who is vulnerable?
China is of outstanding importance for Volkswagen: it is the region with the brand's highest unit sales. Last year, Volkswagen delivered 3.2 million vehicles to customers in China and is the clear market leader in the world's largest and most important automobile market. VW Corporate Newsroom
Potential vulnerability varies across firms. At the national level, the two market leaders in China are VW (OTCPK: VWAGY) and GM, with roughly 17% and a 12% market shares. In the luxury segment, Audi, BMW and Mercedes-Benz are roughly equal, selling roughly 600,000 vehicles assembled in China with additional imports. Then there's Honda, which has the misfortune to have 3 of its 4 plants in Hubei. All of these, however, are joint ventures, so while in good times they only share 50% of the profits, in bad times they suffer only 50% of the losses. (These firms also earn profits from licensing fees, finance, and marketing, which are not through the manufacturing joint ventures and are not detailed. Anywhere. I've looked for the past 5 years.) The other side, though, is that the pure domestic car companies (40% of the market) and components firms enjoy neither the costs nor the benefits of a partner.
A few firms stand out (all data are from company financial statements and investor presentations):
- VW: 40% of group sales were in China, where it has 15 assembly plants (including a commercial vehicle JV) and an additional 17 parts plants.
- GM: 40% of vehicles are sold in China, where CY2019 joint venture sales came to $39 billion. In 2019 they earned $1.123 billion in China, on an equity basis.
- Honda. 30% of sales (1.5 million vehicles) are from China, less than the market leaders, but most of their operations (including motorcycles) were in Wuhan.
- Adient (NYSE:ADNT): they have 86 manufacturing locations across 41 cities and 21 joint ventures in China; Asia accounted for 58% of CY2019 EBITDA.
- Hyundai/Kia: only about 10% direct sales in China, with about 660k vehicles made in their factories there. However, their risk from supply chain issues is higher than any other global OEM.
- Revenue: there has already been a substantial hit from the coronavirus on automotive revenue, at present about 10% of global automotive top-line.
- Earnings: China has been a major source of automotive profits. To my knowledge, the only 8-Ks to date are from Aptiv (NYSE:APTV) and Tenneco (NYSE:TEN). Aptiv notes up to a $200 decline in revenue and a $50 million drop in earnings, while Tenneco reports a potential $150 million drop in revenue and $50 drop in earnings. Yes: earnings fall 30¢-40¢ for every $1 loss in revenue. Autos are a high fixed cost industry. Until more reports, are issued, I do not want to extrapolate.
- I expect the coronavirus to wipe out all Q1 earnings at companies whose primary operations are in China. Publicly-traded assemblers include Beijing Auto Industries (BAIC: OTCPK:BCCMY), BYD (OTCPK:BYDDF), Geely (OTCPK:GELYF) Great Wall (OTCPK:GWLLF), and Guangzhou Automobile (OTCPK:GNZUF). There are also numerous start-ups, and most non-publicly-traded China-based global suppliers such as CATL (batteries), Joyson (airbags, steering gear), Yangfeng (interiors), and Wanxiang (diversified).
- This number will increase the longer the impact lingers in China - I estimate the final tally for 2020Q1 will be 20% of global top-line revenue.
- However, that assumes that coronavirus effects are limited to China. I do not attempt to incorporate what is happening in northern Italy and Daegu Korea into this analysis. Modest interruptions in Europe, Japan and Korea will wipe out all automotive profits for 2020Q1. It is only the ability to mobilize supply chains in these regions that have kept the negative impact on production outside China to a minimum.
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