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Scrapping Hinders Industry Need To Consolidate, Cut Costs

Sales Boost In Short-Term Won’t Eliminate Eventual Pain.
But Some Applaud Scrapping Schemes As Crucial Help In A Storm.

“avoids dangerous sales declines in 2009 and helps auto makers maintain a flatter, more profitable, cycle. What is wrong with that?”

Britain, finally, signed up to provide subsidies for car scrapping, but not everybody believes this move across Europe will benefit the recession-hit industry in the long-term.

U.S. rating agency Standard & Poors said scrapping subsidies, which stimulated car sales in Germany by 40 per cent in March, might offer short-term liquidity relief, but they could impede the industry’s long term recovery.

“We believe only a sustained recovery of consumer demand will bring a lasting rise in vehicle sales. What’s more, government support comes with strings attached that could ultimately hinder the industry’s necessary restructuring process. Such a process, in our view, needs to tackle global overcapacity, industry-wide consolidation, high capital intensity, and automaker’s fixed-cost structures,” said Frankfurt, Germany-based S&P credit analyst Maria Bissinger.

Britain, after agonising openly since last November, finally agreed a so-called “Scrappage” scheme in late April, although it was less generous than Germany’s €2,500 for cars over 9 years old. Britain will offer £1,000 (€1,100), to those scrapping cars 10 years old. Manufacturers agreed to contribute the same amount. The scheme expires in March 2010.

Deutsche Bank said this will lead to 300,000 extra sales in Britain. Similar schemes will add 100,000 in Italy, 200,000 in France, and 700,000 in Germany.

“Overall, Scrappage schemes will boost car demand by 1.3 million in 2009 or 11 per cent of the total car market which should reach 12.3 million in 2009. But negative payback in 2010 could be significant too,” Deutsche Bank said.

More cautionary comments came from the Wall Street Journal’s Sean Walters, who conceded that car sales in Germany, Italy and France had been helped. There are three reasons why Britain has the least to gain from scrapping schemes.

·      Most of Britain’s car production is for export, therefore the lion’s share of the taxpayer’s cash will go to European imports.

·      Historical evidence suggests these incentives simply boost car volumes in the near-term. Sales then fall back sharply.

·      The aid undermines incentives for auto makers to restructure and eliminate chronic overcapacity.

“By distorting demand, raising false hopes and insulating automakers from the worst of the crisis, the scrapping plans are storing up trouble for the future,” Walters said.

Eric Wallbank, head of Ernst & Young’s U.K automotive team, liked the fact that Britain’s scheme extended beyond low emission models and would give some boost to local luxury manufacturers like Jaguar and Land Rover. In mainland Europe, sales boosts have been almost exclusively accounted for by small cars, he said.

Dealerships and components makers will benefit.

“Dealers, who have been seriously affected by the drop in new car sales, should benefit more directly. In addition, suppliers, who produce components for vehicles built outside the U.K. may see increased demand by their manufacturer customers,” Wallbank said.

Investment banker Merrill Lynch, conceding that scrapping incentives pulled sales forward, nevertheless was a supporter.

“Whilst we agree that the European stimulus programmes obviously pull demand ahead in 2009, and will cause a flatter recovery latter, it does avoid the most dangerous sales and production declines in 2009 and helps auto manufacturers to maintain a flatter, more profitable, cycle. What is wrong with that?” Merrill Lynch said in a report.

Italian bank UniCredit agreed.

Help to survive the storm
“The scrapping incentive programme, initiated by European governments, provide what they were intended for – giving immediate support for an industry in the midst of a storm,” said UniCredit equity analyst Christian Aust.

Aust conceded that sales would be distorted, and had some encouragement for the likes of BMW and Mercedes, who have been hit hardest in the recession.

“As scrapping programmes just transfer replacement demand to earlier years, we think that the cycle will be significantly distorted. That is the main reason why we forecast only moderate growth for the European volume market next year. On the other hand, premium car sales are much less distorted from government programmes and the recovery should be more pronounced in 2010,” Aust said.

Fundamental changes
S&P chief economist for Europe Jean-Michel Six said there were other, ominous, reasons why car sales in Europe were unlikely to return to 2007 levels until 2011.

“Several trends have emerged in the past 10 years that suggest that the role of cars in people’s lives is diminishing. First the average distance travelled by motorists is steadily declining, falling by 1.4 per cent per year between 2001 and 2007. We believe this steady decline can be attributed to better public transport systems, the rising cost of fuel, and concerns about the environment, among other things,” Six said.

“Europe’s automakers are also suffering from an extended replacement cycle partly of their own making. In 2007, the average age of cars registered in EU-15 countries was 8.2 years, up from 5.8 years a decade earlier. This increase is in part because the overall quality of cars – and therefore their life expectancy – keeps improving,” Six said.

Neil Winton – April 30, 2009

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