German car manufacturers have made fat profits selling their coveted, high-tech products in the US, but this era is coming to a close as the dollar continues to weaken, and presents tough choices for the likes of BMW, Mercedes, VW, and Porsche. By Neil Winton.
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The German manufacturers could relocate some of their production to the US, but as this is less efficient, expensive and risky, only a huge fall in the dollar against the euro would make this likely or worthwhile. The most likely outcome of the ending of the era of dollar strength is for the German carmakers to shrug their collective shoulders and simply admit that the glory days of what was effectively windfall profits in the US, are gone. They are likely to refocus their sales efforts on markets back in Europe.
Meanwhile, US domestic car manufacturers like General Motors, Ford and Chrysler, long harassed by competition from Europe, Japan and Korea, will be breathing a sigh of relief that at least one source of tough competition is fading away.
Currency hedging and other measures
As the dollar slide has gathered momentum, the German manufacturers have used short-term devices like currency hedging contracts to protect their profits from the ravages of volatile exchange rates, but this can only work for relatively small movements.
For more concrete and long-term relief, there is the possibility of moving some production from Germany to the US. DaimlerChrysler recently announced that it would invest $600 million to double annual production at its Tuscaloosa, Alabama plant to about 160,000 – the M-class sports utility vehicle (SUV), and the more luxurious Grand Sports Tourer.
BMW has raised production at its Spartanburg, South Carolina plant to 150,000 X5s and Z4s, compared with 60,000 when the plant opened in 1994. BMW has planning permission to double Spartanberg output, and with the dollar expected to carry on declining it would seem an obvious move for BMW to protect its profits by moving production to the US.
BMW adamant
But the company is adamant that it has no such plans. At the Frankfurt Car Show in September, BMW management board member for manufacturing Norbert Reithofer told Automotive News Europe that it had no plans to raise Spartanberg output for several years.
John Lawson, European auto analyst for investment bankers Schroder Salomon Smith Barney (SSSB) said it would be very difficult for the likes of BMW to replace lost profits by manufacturing more locally. “US factories are less productive with higher set up costs. BMW is very cautious about adding to Spartanberg, even though about 50 per cent of the sales of Z4s and X5s are in the US. If BMW was to add production of the “3” series for instance, it would take volume away from a very efficient system in Bavaria. Costs are sky high in the U.S. and profitability would be difficult to emulate,” Lawson said.
BMW’s US sales have risen from 131,600 in 1998, to 232,000 in 2002. According to Lawson, VW has been quite clever with some of its manufacturing for the US, making the Bora and Jetta versions of the Golf in Mexico not only for the U.S. market, but for export to Europe too.
Euro jumped 30%
But the economics of selling in the US are under severe pressure for all the German companies. Sales and profits were easy in the late 1990s and early 2000 when the dollar was close to 95 cents to the euro. The euro has jumped about 30 per cent over the past year to its current level of around $1.18.
Some experts believe that the dollar will continue to slide against the euro and could reach $1.40 over the next couple of years. This would be catastrophic for the German companies
“At $1.25 (to the euro) the profits get wiped out at the German companies (in the US),” said Mark Little, European auto analyst at Deutsche Bank. Deutsche Bank’s foreign exchange experts predict that the dollar/euro rate will be $1.25 in 12 months time and $1.40 in two years.
G7 triggers another dollar fall
In a report after the recent Group of Seven (Canada, UK, US, Japan, France, Germany and Italy) meeting in Dubai in September, which triggered another round of losses for the dollar, Deutsche Bank warned about the huge hit to profits that a lower dollar would cause German companies in the US.
“Excluding hedging, we estimate that a 10 per cent drop in the U.S. dollar versus the Euro would have the following impact on European OEMs measured versus our 2003 estimated pre-tax profit – BMW minus 14 per cent, DaimlerChrysler minus 18 per cent, Porsche minus 27 per cent, VW Group minus 21 per cent,” said Deutsche Bank.
Profits slashed
This would mean that €447 million would be slashed from BMW’s estimated pre-tax profit of €3.1 billion in 2003, €644 million from DaimlerChrysler’s €3.6 billion pre-tax profit, €262 million from Porsche’s €987 million, and €416 million from VW’s €1.99 billion, according to Deutsche Bank.
Deutsche Bank’s Little worries that the dollar will indeed continue to slide, as the US government seeks a level for its currency that will allow US companies to compete in world markets.
But not all the experts see a severe dollar crash. Some, like investment bank Morgan Stanley, see a relatively gentle decline of up to 10 per cent, and not the 30 to 40 per cent fall some Cassandras fear.
5 to 10% fall
“Calls for the US dollar to crash simply because of the large US current account deficit are unconvincing, in my view. Unless all of the policymakers in the world make a severe mistake in forcing a crash in the dollar, it will continue to decline gradually. I continue to expect the correction (fall in the dollar) to be a significant 5 to 10 per cent, but gradual,” said Morgan Stanley currency expert Stephen Jen in a recent report.
But even with this relatively benign scenario, the prospects of money making in the U.S. looks bleak for the German companies. According to SSSB’s Lawson, it is unlikely that the heady days of the late 1990s and early years of the current century are every going to be repeated.
Windfall profits
“The period 1999 to 2001 will be seen as a period of windfall profits really, and it is certainly a challenge to replace that profit. The underlying profit potential has done down quite significantly and they need to replace that, but in a very competitive vehicle market that is not easy to do,” said Lawson.
Profit headwind
“Even the current exchange rate means a big headwind to profits; they (BMW, Porsche, Mercedes, VW) are on borrowed time as to profitability,” Lawson said.
Adam Collins, European auto analyst with Germany’s Commerzbank, agrees that BMW would be reluctant to relocate production to the US, not least because the new plant in Leipzig to eventually produce the new “1” series will eventually have the capacity to produce up to 300,000 new cars a year.
Producing, say, the “3” series in Spartanberg, would mean two sets of suppliers. Making cars in one place reduces logistical complexity and adds to flexibility. Workers can easily relocate temporarily to local plants, said Collins.
Porsche may have to concede
Porsche, according to Collins, has the biggest exposure to foreign exchange risk in the US, but has been skilful in protecting itself by hedging. Porsche has no suppliers in the US, no assembly, and no desire to do this. Porsche had the opportunity of moving some production to the US when it decided to make a new SUV, the Cayenne, but it decided to retain production in Europe.
“But if the rate goes to 1.40, even Porsche may have to break some of their rules,” Collins said.
“VW also has limited flexibility. It does have Mexico; that factory only makes the Golf, Jetta and Beetle, while all Audis and Passats are exported from Europe. That’s no coincidence. VW is not prepared to risk quality levels by locating in America,” Collins said.
Huge risks
The companies are reluctant to take the huge risks and commitment involved in moving production to the US, but according to Deutsche Bank’s Little, if the dollar keeps weakening, the question will be asked more and more.
Asian companies have been doing this for years, and according to Little, will have added well over one million units of new capacity over the next four years. This has been seen as a huge threat to the US domestic manufacturers General Motors, Ford and Chrysler.
Big three boost
But if the dollar persists in weakening, that could be a big boost to the so-called big three as the Germans are forced to raise prices in the US. It could also force the Germans to shift their sales concentration back to Europe, said Commerzbank’s Collins.
“The big three will be very happy about this. BMW and Mercedes were favouring US sales over European recently because that’s where they earned most profit. Dealer waiting time in Europe was longer than in the US. If the profit opportunity becomes lesser in the US, they would turn to concentrate again on selling in Europe,” Collins said.
