In the full year 2014, Argentina, Brazil, India, Russia, Thailand & Turkey are set to become an even greater drag on global light vehicle markets than in FY13, declining by at 9.1% or 1.1m to 11.13m units. In the previous five years and during the global financial crisis they were key drivers. Sabine Blümel considers the implications for the industry. This second instalment looks at South America.
Traditionally, South America, and in particular Argentina and Brazil have been a highly profitable region for the European and US OEMs, typically generating operating profit margins of 10%. However, recently this has been undermined by full-blown economic crises in markets such as Venezuela and Argentina, a weakening demand in the largest market Brazil and growing competition due to new market entrants, in particular from Asia.
Argentina – a small market on the brink
During 2013, the Argentinian economy decelerated dramatically. Faced with an over-regulated private sector, economic slowdown in Brazil and weak commodity prices, the government failed to reverse its excessively expansionary fiscal and monetary policies and continued to resort to intervention such as foreign exchange and import controls rather than structural reform to avert a balance-of-payment crisis. After having grown 4.9% in 2013, this year, GDP is expected to decline this year. A de-facto 20% devaluation of the peso in January 2014 was accompanied by insufficient monetary and fiscal tightening and is unlikely to reduce the government’s propensity to intervene.
A weaker currency will also further increase inflationary pressures that the government continues to fight with misreporting and intervention (such as price caps on a large scale). According to independent economists, inflation is set to rise from 25% in 2013 to 30% in 2014, which is considerably higher than the ‘official’ inflation rate of some 11% in 2013 and year-to-date.
The Argentinian light vehicle market that had grown 66% or 8.9% p.a. from 0.54m units in 2007 to 0.90m in 2013, is heading for a collapse of some 30% to 0.64m in 2014. During the first four months, vehicle sales collapsed 35% compared to last year, to 208.0k units because of a dramatically deteriorating economic environment, tighter import restrictions and sharply higher prices caused by the weaker peso. Demand was further weakened by tax increases on cars, in particular on high-end models. There is hope for stabilisation or even a moderate recovery to 0.67m in 2015, helped by likely measures in the run-up to the presidential elections in October 2015. However, the country’s recent default on the servicing of its national debt adds to uncertainties concerning the economy.
Manufacturers most affected by the collapse of the Argentinean auto market are the VW Group (that held an 18% market share in 2013) and GM, Renault and PSA with over 15% each; Ford and Fiat were each at nearer 12%. Premium brands account for less than 3% of the market.
Since 2012, Argentina has been a calculated net importer of light vehicles, in as much production trailed sales. Indeed, Argentina has a very active bi-lateral automotive trade with the four times larger Brazil. Over the past few years, Brazilian-built cars have accounted for 45-50% of Argentinean light vehicle sales and just under 50% of Argentinian production is destined for Brazil. The OEMs that are active in both countries have tried to achieve some division of labour and complementarity in order to generate economies of scale, despite the huge discrepancy in size; Argentinean production tends to specialise in the lower volume segments such as light commercial vehicles and full-sized cars.
Indeed, despite the weaker peso and in view of the weak demand in Brazil and rest of South America, export opportunities from Argentina are limited. This year, Argentinean light vehicle production is thus expected to be cut by more than a quarter, only marginally less than sales, to less than 0.6m units.
Brazil – a large market going soft
The Brazilian light vehicle market had grown 53% or 8.5% p.a. from 2.38m units in 2007 to 3.63m in 2012. It even managed to grow throughout the financial crisis, thanks to three positive factors: first, the Brazilian economy remained strong, benefiting from exporting raw materials and semi-produced goods to a booming China; second, private consumption was even more dynamic, fuelled by subsidised credit facilities; and third, tax incentives for car purchases.
However, during 2013, the Brazilian automotive market ran out of steam and in the full-year 2013 incurred the first decline in a decade, falling by 1.5% to 3.58m light vehicles. Many things have gone wrong. Private consumption, the driving force in 2007-2012, slowed dramatically in 2013, to just 2.3%, in line with GDP growth. In addition, demand for cars has suffered from tighter credit conditions (as interest rates were hiked by 300 basis-points and credit restrictions introduced), shrinking purchasing power (due to inflation running at more than 6% and a 10% weaker currency) and falling consumer confidence. These drawbacks outdid and overcompensated any benefits from the fiscal stimuli introduced since June 2012 (including a temporary IPI tax cut and a permanent reduction of the IOF tax on financial transaction (including auto financing)).
Indeed, the car market subsidies have been partly reversed and the IPI tax (consumer tax) was raised by 2-4%-points (depending on the size of the vehicle) on 1st January 2014. It is therefore hardly surprising that during the first six months of 2014, the Brazilian light vehicle market declined 7.3% year-on-year (to 1.58m units) and is thus heading towards a 4% decline to some 3.44m units in the full year 2014. There is some hope for moderate recovery in 2015.
Private consumption is forecast to remain relatively resilient in 2014, growing 2.1% vs. GDP’s less than 2.0% growth, but only track lacklustre GDP growth in the medium-term. We expect that industrial and commodities sectors will continue to suffer from an only slow recovery in global demand for commodities, overvalued currency, rising labour costs, complex taxes, poor infrastructure and excessive bureaucracy. Growing infrastructure problems and political dissatisfaction are likely to increase strikes and lead to renewed mass protests.
However, the dip in sales numbers by some 5% in two years (2013-14E) is telling only part of the story that is affecting car manufacturers’ profitability in South America’s largest car market by far.
Indeed, the established OEMs in Brazil – Fiat (with a 22% market share in 2013), VW group (19%), GM (18%), and also the smaller operations by Ford and Renault-Nissan (with 9% each) – are facing several considerable challenges, including:
A rising number of new entrants has increased competitive pressures. This is reflected in an accelerating decline in market share held by the BIG Three Fiat, VW, GM from a combined 85% in 1997, to 74% in 2010 and 61% in 2013. Japanese manufacturers raised their combined share to 11%, Koreans to 7% and Chinese to almost 1% in 2013.
The introduction of new safety rules (requiring ABS brakes and airbags) on 1/1/2014, that is estimated to reduce the affordability of cars by some 4-8% and has accelerated the need to modernise the products on offer. As a result, the Big Three had to withdraw their entry-level models and cash cows, that were outdated and based on 30-year old technology.
Production capacity for an additional 1.5m vehicles that is due to go on stream in 2014-15, should keep capacity utilisation well below 80% in the medium term.
As discussed above, Brazil is involved in an active bi-lateral trade with its considerably smaller neighbour. In the past few years, about 20-25% of light vehicles sold in Brazil were imported, about half of those from Argentina. Brazil in turn has been exporting about 15% of its production, mostly to Argentina.
Premium brands account for less than 2% of the Brazilian light vehicle market, because of punitive import duties and a high crime rate that discourages conspicuous consumptoin or ostentation. However, premium sales seem to have taken off more recently growing by some 20% YTD.
Audi and BMW are therefore planning to start local production soon, though on a small scale.
Venezuela’s light vehicle market collapsed from some 420k units in 2007 to just 83k in FY13 and possibly as low as just 20k in 2014. This is despite the fact that Venezuela has the lowest petrol price on the planet, at USD 0.01 per litre. We mention Venezuela here only because the key OEMs operating in the country (GM, Ford, Toyota and Fiat-Chrysler) incurred combined losses of more than USD 1bn in the first quarter of 2014. The Venezuelan government that had run a regime of strict foreign exchange controls since 2003 has now adopted a three-tiered exchange rate system and provides dollars at the official rate of USD/VEF 6.3 only for imports of bare necessities such as food and medicine. Inflation is running at 60%, real interest rates are at-45% and the forex rate on the black market is reported to be close to 70 VEF per USD.
Lack of foreign currency has resulted in a collapse in car production: while in 1Q14 less than 4,000 cars were assembled, production has all but stopped in April-May. Toyota suspended production in February and Ford in early May.