AUTO INDUSTRY OUTLOOK FOR 2009

CHALLENGING PROSPECTS AHEAD

SUMAIRA FAZAL
Mar 02 - 08, 2009

The negative outlook of the global auto industry in 2009 is exacerbated by the extent of the uncertainties faced by car manufacturers. In particular, the length and severity of the current crisis are unknown and manufacturers' responses to this crisis are not clear or they are indecisive at this point. The industry as a whole is facing an unprecedented combination of cyclical and structural issues which underpin the negative outlook overall.

Despite the severe and rapid deterioration of auto markets in 2008, overall sales are expected to continue falling sharply in most mature markets, including US, Western Europe and Japan, in 2009. More alarmingly, it is likely that new sales growth is to slow down dramatically or potentially turns negative in several emerging markets.

Uncertain consumer reaction to oil price volatility and new and future power trains as well as original equipment manufacturers' ability to respond successfully to rapidly changing consumer preferences create additional risk.

Limited availability of credit or more expensive borrowing conditions to finance new car purchases are additional factors that will continue to weigh on vehicle sales this year. In this situation, liquidity will be of utmost importance in 2009. Potential difficulty to access the financial markets and banks to fund working capital and refinance short-term maturities will put further pressure on manufacturers in the coming year. Other issue affecting most, if not all, is that auto manufacturers need to support suppliers, dealers and or/ financial captives (subsidiary financial groups).

Most manufacturers have already reacted to the steep deterioration in the market conditions with major production cuts, which ultimately affect operating profit and cash flow generation. Furthermore, restructuring actions are likely and will be another financial burden. This trend is likely to continue in 2009. Profitability and cash generation should be materially lower and debt leverage will increase. The expectations are such that overall financial metrics will deteriorate substantially in almost all regions.

In the wake of falling operating margins, negative cash generation and weakening financial profiles, several auto manufactures have called on governments for support. Financial assistance provided by the US to its domestic manufacturers has prompted other companies to request similar help in their regions. A number of European countries have already announced financial aid packages to their auto industry, in form of loan guarantees, credit lines, and special loans for the financial services subsidiaries as well as various subsidies or tax incentives to boost new car sales.

Some of the critical issues in 2008, including soaring raw-material prices and brutal foreign-exchange movements, have receded recently and put less pressure on manufacturers entering 2009. All these issues will reshape the industry in the short to medium term, but the extent and timing of changes to come are largely uncertain. However, following the current turmoil, which may last a few years, winners will emerge. Success will depend on the ability to develop and produce a wide range of attractive vehicles for major markets, a strong brand image, ability to reduce production costs continuously, solid links with major and successful suppliers, strong retail network in major markets, and robust financial flexibility to maintain high level of R&D and capital investments. Other includes induction of advanced environmental technologies for next-generation in vehicles including hybrid clean diesel, electric and fuel-cell vehicles, and efficient production systems.

The overall outlook of the US auto industry remains negative due to current US recession, increasing unemployment and lack of financing for retail demand. Although recent US government aid to General Motors and Chrysler Financial has moderated the rationing of credit that occurred in late 2008, tightening lending standards and lack of capital by third-party creditors will add to the pressures on financing arms and keep industry sales levels below actual demand.

There are several positive factors on the horizon, but these will remain overshadowed by economic weakness and industry risks. Lower commodity prices will reduce direct material (steel in particular) and other indirect costs, saving that will be felt more materially in the second half of 2009. Falling gas prices will also improve consumer-purchasing sentiment.

Pakistani Auto Sector has seen one of the longest and strongest positive cycles in previous recent years. Sales growth, however, now faces a severe year-on-year fall. Year 2008 has turned out to be a challenging year for the auto sector in which volumetric sales have registered significant decline. The sector's volumetric sales plunged by 25% YoY to 149,739 units in 2008. Moreover, it seems that demand has yet to hit the bottom as month on month numbers show continuous decline. The domestic auto industry is facing competition from relatively low cost imported cars.

Many auto assemblers are planning to curtail production to single shift basis due to steep fall in utilization levels. Like many other industries, auto sector's demand was also a victim of high inflation, soaring interest rates, steep hike in vehicle prices and economic slow down.

Pakistani rupee had a severe battering during 2008 by major currencies, especially USD and yen that appreciated by 28% and 58% respectively, adversely affecting the auto sector. The unprecedented appreciation of yen has translated into soaring cost of production for the auto assemblers in the country. Increase in selling prices was not sufficient to cover the skyrocketing cost of production.

The sector recovery seems delayed due to various macro-economic factors, including tight liquidity, and lower credit availability, slower GDP growth rates and the current depressed consumer sentiment.

Year on year, growth rates are likely to remain depressed and even negative for the large part of 2009, partly due to the high base effect of previous years. The recovery remains contingent upon income visibility and political and economic stability. Also, the government should consider a suitable cut in federal excise duties imposed on cars, clamp a time-bound ban on import of used auto parts and vehicles to provide a protective cushion to the local manufacturers. Grant of governmental concessions can later compensate the revenue losses in the shape of increased automobile sales.

This crisis can only be effectively managed if there is an improvement in the economic and financial situation of the country, which does not seem to be in the realm of immediate probability, although the economic managers are hopeful of an early turnaround. There is a need for the regulators and the government to be able to cater to the needs of the sector to ensure that the crucial segments of engineering and LSM industry remain growth-oriented.