Increasingly adverse conditions in European auto manufacturers’ domestic markets are weighing on their profitability and cash generation, according to Fitch Ratings.
The credit ratings agency (CRA) says that all European manufacturers, excluding Chrysler from Fiat’s consolidated earnings, reported lower operating margins from their core automotive operations in H112 compared with both H111 and 2011. Fitch also expects the challenging environment to put further pressure on full-year 2012 results across the sector.
Peugeot and Fiat’s European operations were the most impacted with auto operating margins down to negative 3.3% and 3.7%, respectively, in H112 from 1.8% and negative 2.1% in H111. Renault’s auto operating margin remained positive at 0.4%, but decreased from 1.1%, while the operating margin of Volkswagen Group’s four largest automotive brands declined only marginally to 6.3% from 6.6%. Daimler’s and BM’’s auto operating margins decreased, albeit to a still healthy level, to 8.5% and 11.6%, respectively, from 10.0% and 13.3%.
“European carmakers’ profitability and cash flows continue to suffer from falling sales and from the deteriorating pricing environment in Europe, which affects both revenue and earnings and impacts premium and volume manufacturers alike,” said Emmanuel Bulle, senior director in Fitch’s European corporates group. “In addition, manufacturers either not, or less, present in growing markets outside Europe, or those currently incurring investment costs to ramp-up their presence there, are suffering relatively more.”
The CRA says that despite lower earnings and weaker cash from operations, the majority of European manufacturers have sufficient headroom in their ratings to avoid negative actions in the short term. However, pressure is building on those companies’ rating with a negative outlook, namely Fiat and Peugeot.
While aggressive pricing conditions were mostly a concern for mass-market manufacturers, there is increasing evidence and comments about premium brands also suffering. It is a recurring but increasing issue in Europe, where manufacturers fight to at least maintain market share in a context of falling sales. New car sales were down 6.9% in western Europe in H112 and Fitch expects them to weaken further in H212, closing the year down between 7% and 8%.
The issue of deteriorating underlying pricing has been compounded for several manufacturers by the costs related to the phasing out of a few key products and their renewal. This includes Daimler’s compact cars (A- and B-class), Renault’s new Clio and Peugeot’s 208. Volkswagen is typically less dependent on one or two single products, but earnings and cash flows were hurt by development costs associated with the group’s new modular strategy.
Although profitability was down compared with last year, Fitch believes H112 earnings were more resilient than broadly expected for some European carmakers. The main positive factor which supported revenue and profitability was the sustained growth in large non-European markets such as China, Russia and the US. Car sales were up 14% in North America, 2% in South America and 16% in Asia-Pacific in H112, contrasting noticeably with the sales decline in western Europe.
The CRA adds that their absence from, or relatively smaller or too recent presence in these growing markets, is a particular issue for Peugeot, Renault and Fiat (excluding Chrysler). Their sales remain concentrated in Europe, with a bias to weaker southern markets such as Spain, Italy and France, where the eurozone debt crisis has had the most impact on new car sales. All three manufacturers also derive the majority of their revenue from the less profitable small and medium-sized car segments, where competition is fiercest and price pressure is strongest. Chrysler is boosting Fiat’s consolidated earnings, but the current strict ring-fencing of debt and cash flows limits the benefit of Chrysler’s improvements to Fiat as the latter has no access to Chrysler’s cash at a time when its standalone cash generation ability has weakened significantly.
Fitch intends to reassess its view on the European auto sector overall within the next two months following a further review of Peugeot’s, Renault’s and Fiat’s current and expected performance and a deeper comparison with close international peers.
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