• PSA capacity utilisation in Europe has plummeted in 2012 as demand for small cars has slumped
  • Aulnay especially exposed as output this year declines to projected 130,000 units for the year and just 56% capacity utilisation
  • PSA still needs to do more to raise capacity utilisation in Europe above breakeven
  • Spotlight may now shift to Villaverde plant in Spain

PSA has moved decisively to rationalise its European production capacity in the face of declining capacity utilisation and a slump in demand for small cars. Aulnay, maker of the Citroen C3, was an obvious weak point in the company's European manufacturing footprint.

The actions announced today, PSA said, are necessary as the company projects a net loss for the first-half of the year.

Europe's extremely weak car market environment is intensifying the squeeze on those makers who are relatively reliant on it and for PSA, the writing has been on the wall for a while on its European operations' overcapacity.

The demand side looks brutal. Car sales in Western Europe this year are projected to be down 6% at around 12m units according to LMC Automotive. This year's decline follows decline last year and leaves the car market around a fifth off pre-crisis levels. PSA faces an added squeeze in small cars (42% of its sales are small cars) as southern European markets where they sell well come under the greatest pressure and see the largest declines. Further, Spain's car market – an important one for PSA - has been decimated in this crisis and car sales in France are off 14% so far this year.

A look at the manufacturing capacity numbers suggests that Aulnay, maker of the Citroen C3, was especially exposed as unprofitable. PSA itself says that there is a need to adjust inventory this year in Europe due to the market being weaker than it forecast. It says group production contracted by 18% in the first half after a 10% drop in its sales.

Overall capacity utilisation, it says, fell to an average 76% in the first-half from 86% in 2011. Well that doesn't sound too bad does it?

But hang on a minute. How are they defining 'capacity utilisation'? The PSA figures are based on the Harbour index which works on the assumption of two shifts. In reality, many plants are capable of working on three shifts for maximum efficiency, so the Harbour figures look high.

The analysts at LMC Automotive work on the assumption that three shifts bring 100% utilisation. On that basis PSA was operating in Europe at around 78% capacity utilisation in 2011 and that has fallen to 65% this year. That's against a rule of thumb that OEMs can be profitable at 80% capacity utilisation and certainly suggests a pressing need for capacity rationalisation, the case building this year as the capacity utilisation rate has declined further.

The position for Aulnay looks especially stark. LMC puts Aulnay capacity at 220,000 units. It built 207,000 cars in 2011 and that's dropping to a forecast 130,000 this year – suggesting capacity utilisation for Aulnay of little more than 50%. LMC's forecast had been for Aulnay output to decline to 100,000 units in 2013.

Arthur Maher, LMC's production specialist, estimates that shutting Aulnay will raise capacity utilisation for PSA to around 72% in 2014. But that is still some way off that 80% breakeven level. He believes more action is needed and that PSA will have to shut another plant in Europe. He pinpoints the Peugeot small car making plant at Villaverde in Spain which he says is operating at around 50% capacity utilisation.

The problem for OEMs in Europe is that there is little light at the end of the tunnel in terms of relief from demand (the 'rising tide' that brings naturally higher capacity utilisation). The car market in 2013 is not projected to see a rapid bounceback while serious economic problems and EU policy disarray (eurozone crisis) and uncertainties remain that worry the average European.

Overcapacity, therefore, becomes structural in nature rather than cyclical and requires action. The actions are needed to be announced urgently (the oil tanker effect: there are short-term restructuring costs and closures take a few years to 'work through') in order to remove unprofitable operations that will act as a drag on profitability and hamper future competitiveness.

The tough times and tough decisions in Europe will continue for a while yet.

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