Peugeot Bean Counters May Have To Delay Action
French Parliamentary Elections Will Decide Whether President Can Act
Adam Smith’s Bond Vigilantes May Have The Ace In The Hole
The European automotive industry looked to the French presidential election to produce a catalyst for action.
If incumbent Nicolas Sarkozy had won, then the long-delayed plans to finally cut the bloated European automotive industry down to size would have been dusted off; at least for the French bits like GM affiliate Peugeot-Citroen, and Renault. A win for socialist challenger Francois Hollande would mean all bets were off, with austerity shunned and statist plans to subsidize unviable and loss-making factories cranked up.
In the wake of an Hollande victory, it remains to be seen just how much things will change. Perhaps we will have to await the results of French Parliamentary elections on June 10 and June 17 to see what kind of power Hollande is able to wield.
Chancellor Angela Merkel is unlikely to budge from her determination to force Europe’s economies to reform along lines Germany has already achieved. In France, some say Hollande’s victory was more a mark of distaste for ex-President Sarkozy than a mass rejection of austerity and embrace of socialist values. Action to stop companies downsizing would need large sums of money the government doesn’t have.
“Adam Smith’s bond vigilantes”
The Wall Street Journal in a recent editorial said Europe will be forced to give up the spending spree because it won’t be able to avoid “Adam Smith’s bond vigilantes”, despite what politicians promise. In other words, any European government, like France, which seeks to spend money it doesn’t have, will be pulled up short by investors demanding ever higher interest rates to compensate for potentially unreliable borrowers.
European automotive manufacturers’ need to restructure is a mirror of the continent’s economic problems. It doesn’t include the Germans.
The German government started supply side reforms in 2003, when Chancellor Gerhard Schroeder began to implement a program of long-term structural reform called “Agenda 2010.” After the crash of 2008, German auto makers took harsh action to cut out waste and invested huge sums in capital equipment so that they could be profitable even in high-cost western Europe. French giants Peugeot-Citroen and Renault were given loans of about $4 billion each on easy terms by the French government. European governments (including Germany) lashed out huge subsidies on cash for clunkers programmes. Needlessly to say, no harsh action was taken which might offend the government paymaster.
Hugely profitable
The result is that German manufacturers like Volkswagen and its Audi luxury subsidiary, BMW, and Mercedes are now hugely profitable, despite the chronic weakness in Western European sales. Sales in China and the U.S. have more than compensated for lost European ones. All the other European mass market manufacturers are bleeding various amounts of red ink. Include in that Ford Europe and General Motors Europe, both of which undermine the theory slightly by being mainly based in Germany. That hasn’t stopped GM Europe’s Opel-Vauxhall subsidiary losing $12.4 billion in Europe since 2000, and $747 million last year. Ford Europe expects to lose between $500 million and $600 million in 2012. It lost $27 million in 2011.
Given the massive scale of American losses, you could be forgiven for wondering why Ford and GM don’t simply up sticks and go.
“Ford and GM will hang on in there. They are long-term players and want to capture as much of the global market as possible. Europe is too big to ignore,” said Alec Gutierrez, analyst with Kelley Blue Book in Irvine, California.
Things have become so bad, that some experts point to the possibility, perhaps tongue in cheek, that the Germans might rollover the entire competition.
“Will the European Auto industry be 100 per cent German before the decade is out?” said Bernstein Research analyst Max Warburton.
“It’s not impossible, as the strong get stronger and the weak get weaker. First quarter results carried on where 2011 left off and saw long-established trends continue – the Germans continue to get richer while the French and Italians continue to get poorer. VW is bucking the European recession as it drives its local competitors closer to the wall,” Warburton said.
Warburton said in the past, success tended to be cyclical. Winners would overstretch themselves, and fall back. But since the reforms, German fortunes have been remorselessly successful. In the past, currency devaluations would have allowed losers to get back into the game with price cuts. But with most of the industry locked into the Euro single currency, that option has disappeared.
Warburton doesn’t expect crucial restructuring will take place.
Bedrock
“Capacity isn’t going to come out, at least not in a structured way. Can losses get worse? Potentially, but in our view pricing has been cut so heavily that we have hit “bedrock” – gross margins are minimal and it is difficult and illogical for manufacturers to cut pricing any further. If that’s the most positive thing we can find to say on Europe, then it says it all,” Warburton said.
European overcapacity is said by many to be at least 20 per cent of total capacity while some say it is close to 35 per cent.
Stefano Aversa, co-president of the Alix Partners consultancy, doesn’t expect radical action either, but sees the troubled Europeans gradually putting their houses in order. Aversa doesn’t see European sales returning to 2007 levels any time soon. A slow recovery will start in the next year and a half, before returning to much improved volumes in 2016, 2017, 2018, although not necessarily to previous peaks.
Manufacturers will cut, although he doesn’t expect drastic action.
“Every manufacturer in every country will have to find its own solution. There is increasing clarity that the industry will have to adjust one way or another. There have to be ways to minimize social impact and for their companies need to be more creative. Look at the U.S., where about 128 plants have been closed since the early 1980s. Some have been converted to other industries, or have become shopping malls,” Aversa said.
There are unlikely to be easy solutions.
Stealthily, discreetly
“It will be slow but sure. The revolution will be on a long tide and not be a tsunami. There are a number of things to do to make the boat lighter and float easier but there’s not a single big weight you can throw overboard that will solve the current problems. Not a single one. You can’t just close 12 plants and say it’s all over,” Aversa said.
Emmanuel Bulle, analyst with Fitch Ratings in Paris, shares Aversa’s view that change will come stealthily and discreetly.
“The result of the French elections will undoubtedly complicate Peugeot-Citroen’s and even more Renault’s strategy and decision making processes, but my view is that they reached a point where some measures will be taken as far as restructuring is concerned. Such measures may be less vocal and more discreet, and may take more time, but I believe that overcapacity will be addressed in one way or another, including in France,” Bulle said
Americans might be inclined to feel a little smug when they compare tough action taken in the U.S. with the feeble response in Europe. According to ratings agency Standard & Poors, the European industry removed six per cent or 1.2 million units of capacity between 2005 and 2012. North America cut 5.1 million units or 27 per cent via shift reductions and plant closures over the same time.
European politicians have been frightened to allow plant closures because of the inevitable reaction at the polls. Two million jobs directly and 10 million indirectly are dependent on the auto industry.
Provocation
There is one glimmer of light on the horizon for the French and Italians. Labor unions in Germany are on the march and have recently staged walkouts at Audi, Porsche and Mercedes. The German engineering workers union is demanding a pay increase of about 6.5 per cent. The IG Metall union has rejected a three per cent wage offer, labeling it a provocation.
It might be stretching the imagination a bit to think German auto makers might be priced out of the market if they cave-in to crippling wage demands. That dream might quickly fizzle anyway because French labor unions are flexing their muscles, saying despite the win by the Socialist Party’s Hollande, top manufacturers in France are about to announce big layoffs.
Neil Winton – May 15, 2012
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