In the first of a series of conversations, just-auto editor Dave Leggett and GlobalData lead automotive analyst Calum MacRae discuss some of the big questions prompted by the unprecedented coronavirus crisis and its impact on the automotive sector. In this first caffeine-powered instalment, they consider the rapidly changing global business landscape.
Calum MacRae: So Dave – you must have been round the block in this industry a few times now?! Can you recall a time like this in the years you've been following the industry? I've been through a few recessions in my time but I don't think anything quite compares to this in terms of severity and speed…
Dave Leggett: Nope. I can recall – as a kid – the big recessions in the 1970s – caused by sudden oil price hikes and Middle East geopolitics, the European recession of the early 1990s and, of course, the recession ushered in by the financial crisis in the late Noughties. Along the way we have also had 9/11 and the bursting of the dot.com bubble. This situation is very different, a pandemic that forces governments to put their economies into comas, shut almost everything down. It's an unprecedented situation today, but people do wake up from comas of course. It will end, we just don't know when and what permanent scarring may be left.
CM: Interesting analogy there. Much like some comas, this has – to a degree – been medically induced. And we'll be beholden to the powers that be that will decide when the economies exit this semi-vegetative state. As you say, the problem is we just don't know when this will all end, giving the situation so many outcomes. Tough time to be a forecaster! Of course, the longer it goes on much of the fabric that carries economic life may be irreparably damaged and that will give us a whole new set of variables to enter into our models. The hope has to be the world bounces back in the manner that China appears to have done, but I see there's worrying evidence that suggests the virus may be transmitted by airborne pollution. The epidemiologists and policymakers are on a learning curve, feeling their way it seems.
DL: I am reminded a little bit of the sudden shock to the world caused by 9/11. People and companies just stopped spending and cashflow problems quickly hit; the Federal Reserve slashed interest rates and the world followed. Of course, back then the authorities had the powerful lever of interest rates to work with – that's not really available now – we've got used to cheap money and it can't really get any cheaper. Governments have had to go with direct support for individuals and companies. It's a very tough situation and it looks like it doesn't come with an easy 'hit the switch' solution in terms of the public health challenges. Companies, I think, need to be in crisis mode, focused on survival and doing what needs to be done to get them through to the recovery period. My feeling is that not everyone will be left standing. Cash is King.
CM: Yes. I'm always reminded at times like this of the old Warren Buffett saying, "When the tide goes out, you end up seeing who's been swimming naked." Aside from the lack of suitable attire, do you see any indicators out there that would indicate which companies might be in trouble in this situation? I suppose we have to look at company liquidity and I guess the Altman Z-score will be back in fashion again like it was in the 2008/9 crisis?
DL: Love that Buffett quote. Yes, a big economic crisis always brings a few nasty surprises, but also exposes some failing businesses who now have nowhere to hide. The additional pressure on business tips them over the edge. And, also, there are the agile performers who are capable of adapting and reacting quickly to radically changed circumstances. The companies who moved quickly to prioritise cashflow, all credit to them. And we can see some companies taking actions that must be uncomfortable, but make sense in the new normal and a need to focus on core activities. GM's Maven axe for example. I think we should look out for examples of corporate agility to bolster cash and also take cost out wherever possible.
CM: Any action that cuts costs, conserves cash and secures credit has got to be looked upon favourably at the moment. The cutting of Maven is an example of an unwanted distraction that companies don't want at the present. There's got to be a careful balancing act between conserving R&D – that gives you long-term competitive advantage after all – and cutting costs to the bone though. And measuring R&D effectiveness is difficult at the best of times. However, I do get the feeling that for the past few years the industry's been distracted from its core purpose. It's tried to pivot away from what made it money in the first place and allowed a little bit of, what we used to call in economics, 'x-inefficiency' to creep in. A certain amount of hubris if you like after surviving the last recession, getting record profits from the massive shift to SUVs and the (almost) exponential rise in the Chinese market.
So I do think the auto industry has taken its eye off the ball to a degree – allowed itself to be distracted by too much blue sky thinking around mobility for instance – and forgotten what allows it to make money in the first place.
DL: Oh yes, I agree. The last ten years have been something of a golden period for automotive companies. China was a giant cash register that kept ringing for one thing. That pumped up profits and the OEMs also realised they could churn out high-margin products that people were prepared to sign for on leasing agreements or PCPs, aided by cheap money and low monthly repayments – it's been a high old time. At the same time, some executives – and investors – got off on throwing CASE meat to the R&D departments. Future mobility became an enthralling narrative. I think we're getting a bit of a rowing back on all that now; it seems far less important when you are facing an existential crisis and planning is focused more on the short-term. I'd say the very long-term rationale in how mobility is changing still holds, but the companies in a good position now are the ones that can start to address what is going to be sustainable in the still-to-be-determined environment of the post-covid business landscape of the next 2-3 years.
Many assumptions that underpinned company strategies three months ago have to be revisited, no doubt about that. The basics are to the fore. What can you sell? Where do you sell it? What margin on that vehicle? How will that make this year's quarterly results look, top lines and bottom lines? What is necessary cost, what is a luxury in the 'new normal'. No sacred cows left.
CM: I think we'll see a lot of complexity reduction going forwards. Complexity kills after all. I'm reminded a bit of the tangle many companies got themselves into in the 1990s – you know, apocryphal tales of 50 different cigarette lighters for one standard car in your line-up, that sort of thing. I don't think it's as simple as that now. The other unknown is whether buying habits will have fundamentally changed. Will people feel better about working from home, use the car less, not be two car families any more or will it be the case that two cars is more of the norm to keep away from public transport? Do you think that could favour any vehicle segments over another?
DL: That's a good question in terms of permanent societal changes and impacts on automotive demand. I reckon the push will be towards more electrification and also generally towards smaller and less expensive vehicles. This crisis has caused a substantial reduction in CO2 emissions and many people have welcomed the opportunity to walk or jog in less congested city streets. The politicians and regulators, I suspect, will want to build on some CO2 friendly behaviours, like encouraging electric cars. If people do use their cars less, how much personal capital do they want tied up in it? They may naturally be more inclined to limit that in the future.
The zeitgeist for a while to come may not favour conspicuous consumption. Premium brands could suffer, though the super rich people of high disposable wealth will still be there. They may not want to flaunt it though. Pressures on public spending could usher in a period of austerity in some countries also.
CM: That's an interesting take on possible societal changes. You could well be correct that post-covid will usher in a more altruistic society. But then, if you look at the oil price drops and how that directly effects pump prices in low fuel tax countries like the US we could well see a spike in demand for more V8 behemoths! Conversely, though, in some countries like those in the Middle East and Russia particularly there's a really high correlation between oil prices, wealth effects and conspicuous consumption. So it's certainly not a one world view. Which brings me to the next point, do you think this crisis curtails or kills globalisation? That's certainly something that's been posited in some circles and in auto we all too frequently see the fragility of global supply chains…
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