COVID-19 crisis will pound auto industry profits, AlixPartners exec says

Stefano Aversa, who leads consultancy AlixPartners in Europe, says the auto industry “needs to forget 2020 as soon as possible and move forward.” His company predicts the coronavirus pandemic will cause European vehicle sales to drop by 32 percent this year, which will hammer profits. Therefore, he predicts many most automakers and suppliers will use 2020 to “clean up their balance sheets.” Aversa discussed this and more with Automotive News Europe Associate Publisher and Editor Luca Ciferri and Correspondent Andrea Malan.

The Global Automotive Outlook 2020 that AlixPartners published on June 8 envisaged two possible scenarios for European vehicle sales this year in light of the pandemic. The baseline view was that sales would be down 32 percent compared with 2019. The more drastic view was that there would be a “prolonged recession” with deliveries falling 36 percent. Which is the most likely?
Our baseline forecast of a 32 percent decline is the most likely. We are more pessimistic than most observers [industry association ACEA, for example, predicts a 25 percent decrease], but barring a major new wave of infections, I feel the prolonged recession hypothesis is too negative.

How about the other major markets?
China staged a typical V-shaped rebound, with sales already back to a pre-pandemic level. North America is in the middle. We forecast a 21 percent decline in 2020 followed by a quick recovery in 2021. The November elections in the U.S. will help sustain the rebound, as they usually do. The fiscal stimulus measures already put in place [in the U.S and Europe] are unprecedented, they are much larger and have come much faster than those taken in 2008. Europe suffered from a stricter, longer lockdown, therefore the recovery so far has been inconsistent.

Could the recent rise in coronavirus cases in the U.S. endanger the recovery there, especially if authorities impose a new round of lockdowns?
So far, authorities are locking down bars and restaurants more than car dealerships and production sites. In addition, inventories of SUVs are still very low.

Back to Europe, ACEA has not officially asked the EU to delay the implementation of the new, tougher CO2 emissions rules. Do automakers need to ask for this to avoid billions of euros in fines?
I’m quite sure such discussions took place behind the closed doors, although no official request has been made public. Just the technical delays in homologating and launching the new models that would help automakers reach the stricter CO2 targets would justify at least six-month delay in the implementation of the new rules structure. It’s common sense.
 
How long of a delay would you expect?
Six months wouldn’t solve the problem. A one-year delay would make more sense and be the right solution. Nearly everybody will lose money this year. The car industry needs to forget 2020 as soon as possible and move forward.

Do you think any auto companies will manage to make a profit in Europe this year?
Most of them will not, although some automakers do have enough financial flexibility to do it. I believe most automakers and suppliers will use 2020 to clean up their balance sheets. Given that the results will be negative, they might be tempted to add restructuring charges to solve also some pre-existing issues.

Will automakers exposed to China also be at risk?
That exposure might mitigate the negative factors for automakers such as VW and BMW, which have sizeable China operations that make a large contribution to their profit pools.
 
Is PSA at increased risk because of its heavy dependence on Europe for sales?
A more than 30 percent decline in European sales will inevitably have a negative impact on their good 2019 profit margins. On the other hand, both French automakers can leverage two positive factors: first, the social safety net the French government has put in place; second, the country’s scrapping incentives, which also include internal combustion engine cars. France took a pragmatic approach and the market reacted with a quick sales recovery [France reported a year-on-year sales increase in June, helped by the incentives].
 
How about Fiat Chrysler Automobiles?
FCA gets most of its profits from North America, but it has a large part of its fixed costs in Italy. It made a small loss in Europe before COVID-19 and those losses will grow, but the Italian social net will help. In general, there are too many moving parts to make solid forecasts, and I know every automaker is scrambling to simulate all possible scenarios. Analysts have already written off 2020. Nobody looks to the 2020 results to evaluate a company; everybody will look to 2021 and beyond. Mind you, the most important issue in such a crisis is cash -- not just cash used in your operations, but the cash you need to support the entire supply chain. Governments also pressure automakers to act as supply chain leaders. That’s the case of France, Italy and elsewhere.
 
Which parts of the value chain have suffered most because of the pandemic?
Small- and medium-sized suppliers that rely on a single automaker customer. Those suppliers tend to be part of national supply chains.
 
Will dealers also suffer?
That’s another big story. Dealers have huge unsold inventories, and automakers will have to step in and help finance those stocks or support campaigns to sell off the overstock. Banks will also have to help. Automakers started to use reverse factoring to support suppliers, while dealers will ask for some payment rescheduling.
 
Do you forecast a wave of suppler and dealer closures?
There will surely be an increased number of bankruptcies and more alliances and even consolidation to share the increasing development costs. Those companies that were hurting before the crisis will have a tough time surviving. Banks will also be more cautious about lending money to financially stressed companies, unless there is a government guarantee.
 
Will automakers need to save critical suppliers?
There have already been some cases. Small suppliers are not a problem, no matter how critical, as their dimensions are manageable. Midsize suppliers with three or four big customers are more problematic and might require different solutions, such as searching for alternative suppliers. Every purchasing manager has a number of these issues to handle and it will continue over the next six to 12 months.
 
According to the AlixPartners study, crossing the “profit desert” will take 18 to 24 months. To sustain themselves will automakers need to make even more drastic cost-saving decisions so they are leaner by 2022?
After the 2008-09 crisis, automakers started accumulating fixed costs again. That is a natural process because when you build your muscles you also tend to add some fat. This raised their break-even point, which was justified by a growing industry. 2018 was a record year for automotive both in revenues and profits, but both started to decline in 2019. Then the COVID-19 crisis came, resulting in a renewed need for structural measures. You can’t keep an organization running at a loss or with anemic cash flow for years at a time when you have to continue investing so much, particularly into electrification. In our study we suggest that automakers set a break-even capacity (not just production capacity) for a worldwide production level of 65 million to 70 million vehicles a year, which is the expected level for 2020, versus the pre-pandemic level of 85 million. This year’s likely loss of almost 20 million vehicles is like wiping out the whole European market.
 
What is the difference between overall capacity and production capacity?
We are mainly talking about SG&A [selling, general and administrative expense] breakeven. As far as assembly plants are concerned, closing one of them would reduce costs by no more than 150 million to 200 million euros. That is because most large assembly plants in Europe have already disappeared. The typical plant has a production capacity is 200,000 to 250,000 units. Closing one of these factories, however, creates big social and political problems without bringing huge financial advantages. That’s why automakers do it only when they have no other alternative.
 
How much would each of those closures cost?
We can estimate 400 million to 500 million euros, so it takes three years to recover the money spent, but the cash outlay is upfront.
 
How many vehicle assembly plants should be closed in Europe in the next three years? And, how many closures do you expect?
In 2008 we had estimated there were at least 12 plants too many in Europe. Since then automakers closed three of them and a couple a new, small ones have been added. The current crisis has triggered a much steeper sales fall, but we also expect a quicker rebound. Therefore, we can imagine that out of the current 142 passenger car assembly plants a similar reduction of a dozen plants would be justified, but the actual decision on whether to close them has more to do with politics than business. Besides, we often focus on assembly plants, but the current 78 powertrain plants will also be hit by the slow and steady shift toward electrification.
 
How will that play out?
In the short term, employment might even grow at powertrain plants because hybrid cars still need an internal combustion engine. Over the next 15 years, though, some restructuring is inevitable. Europe might lose between 30 percent to 40 percent of its engine and transmission production. It is possible to convert some of those plants to producing electric motors, but there will be a 10-to-1 reduction in the space and workforce needed.
 
Talking about electrification, according to Alix Partners’ report, the low volume per platform for battery-electric vehicles puts them at a significant fixed-cost disadvantage. Can you quantify that?
The most significant fixed cost is R&D. We expect in the next five years the industry will invest more than $200 billion in electrification, which will have to be charged to an average sales volume of 34,000 units per platform of electrified models.
 
So how much does R&D weigh on a battery-electric vehicle compared with a car powered by a combustion engine?
R&D normally accounts for about 4 percent on a volume car with a combustion engine. It can be 20 percent to 30 percent on EVs, depending on the volume of production. This should drop to 12 percent by 2027, but that is still three times more than on cars with traditional powertrains.
 
How can you envisage a mid-decade tipping point for EV acceptance when R&D alone accounts for an additional burden of 8 percent?
Most automakers sell EVs at a loss now, but a closer look reveals a small number of vehicles with reasonable sales, including the Tesla Model 3, Nissan Leaf, Renault Zoe. That being said, there are still a lot of competitors with very low sales and no hope of making money. Some compensation, however. does come from the avoidance or reduction of the potential fines for exceeding CO2 emission targets.
 
Alix Partners estimates the cost of an EV powertrain for an SUV is about 20,000 euros. If a reasonably sized battery currently costs 10,000 to 12,000 euros, where does the rest come from?
Battery management software and development costs play a relevant but little-known role. That is especially true for plug-in hybrids.
 
Will these costs drop at the same pace as battery costs? When will EVs achieve cost parity with cars that have combustion engines?
It’s very difficult to forecast because it depends on so many factors: kilometers driven, the price of fuel versus the price of electricity, the price of batteries, and, of course, government subsidies. We have up to 12 parameters in our model. While the economic viability of EVs is far from certain, subsidies play a big role [in promoting sales]. Moreover, the very low cost of gasoline in the U.S. makes the purchase of an electric car impossible to justify on purely economic grounds. Generally speaking, Europe is a much more fertile ground for electrification than the U.S. because of its structure, shorter distances of travel, its electric grid and its ecological sensitivity.
 
But subsidies cannot continue forever, as we have seen in China. What will it happen when governments stop offering incentives?
At that point, other economic parameters need to close the gap. For people who drive short distances, battery-electric vehicles will hardly make economic sense, but they might be the most convenient choice if cars with combustion engines are banned from certain city centers or a lifestyle choice if the person has decided to move away from a car with a traditional powertrain. BEVs might not be the solution for people who drive long distances. That is why we are betting long-term on hydrogen.

Some of hydrogen’s advantages are clear such as the longer range and shorter refueling times. But it’s expensive to produce so doesn’t it only make sense for a limited number of vehicle types?
If we look at trucks, hydrogen beats batteries handily. You can’t load 10 tons of batteries to move 20 tons of goods, unless it is for short hauling. Longer term, I believe hydrogen will also be competitive for cars, especially SUVs. There are two reasons why: hydrogen’s high energy density per kilogram and because hydrogen can be used to store energy obtained from renewable sources such as solar or wind that would otherwise go wasted or would require huge and expensive battery packs. It can be easily moved around in canisters or shipped in existing pipelines over long distances at no loss. The challenge during the next 10 years will be significantly reducing the cost “clean hydrogen” production equipment and of the fuel cells that convert hydrogen into electricity. Both targets are realistic.
 
What scenario do you have in mind?
Battery technology will improve, but it’s neither the only nor the final solution. Today it’s a “green” solution for people who commute up to 200 km a day. CNG is a good solution for urban transportation, with extremely low particulate matter and NOx emissions. Vehicles with combustion engines are today the most competitive solution for most applications. Multiple technologies will coexist for a long time, including hybrids, which are rather costly and a bridge solution, but the ultimate winner might be hydrogen.
 
Why does AlixPartners forecasts a slow uptake for autonomous driving applications?
First of all, Level 5 vehicles, which have no driver and possibly no steering wheel, will most likely never happen. It is too costly and too difficult to cope with every possible driving situation. There will always be a case where the vehicles will stop and ask, “What should I do?” Level 4 make sense for robotaxis, which will have a high enough utilization to make it easier to amortize their high costs. Level 3 autonomy, the so-called “eyes-off” driving, is making great progress, but won’t be on the mass market for a while. We see a very low take up until 2025 because of lack of regulation and low acceptance by consumers. Sales will gradually grow, starting with fleets, particularly robotaxis or trucks on fixed routes. In our view, the growth in this area will come from the launch of increasingly sophisticated and affordable driving assistance systems, with an aim of reducing accidents. Those systems will gradually become compulsory on new vehicles. We also expect the current COVID-19 crisis to force a significant slowdown in autonomous vehicle investments, which are not crucial especially at companies that are struggling to finance other more essential short-term projects. By the way, studies have shown that autonomous vehicles would not reduce city congestion. Even if there is no driver, the vehicle is still on the road. The only advantage would be that a robotaxi would potentially work 24 hours a day with no driver. To do the same, a yellow cab in Manhattan today would require three different drivers.
 
When will I be able to take a nap while my car is coasting along on a highway?
It unlikely before 2030. And again, that will mainly make sense for commercial vehicles that travel long distances.
 
Isn’t it already technically feasible?
It is, but it requires specific autonomous-enabled routes and international standards, which won’t be ready and certified before 2030 or so. The point is that those routes have to be carefully managed. For example, if the road is undergoing maintenance or repairs those sections will have to be certified for autonomous driving, too.
 
How realistic is Elon Musk’s statement that Tesla is close to offering Level 5 autonomy?
Maybe in well-defined and controlled areas. For a robotized vehicle, getting to Mars might be easier that finding your way around Mumbai.