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Auto Sector May Face Profitability Pressure From Slowing Demand, Emission Rules, Trade issues in 2020, Fitch Ratings Says

The global auto sector may face see profitability pressures this year from slowing demand, stricter emission standards and trade uncertainties even as financial profiles in the industry have improved since the economic crisis of more than 10 years ago, Fitch Ratings said Wednesday.

Analysts from the firm, led by Stephen Brown and Emmanuel Bulle, said in a note that they expect “new emission regulations and cyclical” will push new vehicle sales in Europe lower and will continue to be “robust” in the US. Sales in China will “modestly recover” following two straight years of declines.

“Investments in electric and autonomous vehicle development and greater connectivity will weigh on (free cash flow) but come with uncertainty regarding timing of payback,” the analysts said. “These technologies will also support continued (mergers and acquisitions) among suppliers to obtain expertise or increase sales.”

They said electric vehicles are less profitable than gasoline-powered cars, but automakers have to increase sales of EVs to comply with 2020-21 European emission regulations in order to avoid penalties.

“EV adoption rates are uncertain due to insufficient charging infrastructure causing customer hesitancy,” Fitch said. “Automakers could start taking provisions in 2020 and Europe, given risk of compliance.”

Despite agreements the US reached in the past few months with China, Canada and Mexico, trade issues may continue to hang over automakers’ supply chains. “China trade despite a signed phase one deal did not resolve much for the auto sector, and US tariffs on European imports remain wildcards,” said Brown and Bulle. “Trade barriers would be detrimental to the industry even if perceived to benefit the US.”

They said in the US, Ford Motor (F) is in a weaker position compared with General Motors (GM) because it’s restructuring global operations while investments are needed to stay current with advances in technology.

“Ford’s strong liquidity provides good flexibility but maintaining its existing credit rating depends on progress with the program and realization of expected benefits,” according to the analysts.

Fitch said suppliers that are behind in advanced technologies and have not prepared for “structural changes in the industry may also be risk.”

The analysts aid BorgWarner (BWA) has used mergers and acquisitions to expand its electric powertrains while Tenneco (TEN) could be hurt by a sped-up shift towards EVs. They said Aptiv’s (APTV) focus on semi-autonomous and autonomous systems puts it at an advantage while Delphi Technologies (DLPH) is at a disadvantage due to Europe’s shift from diesel powertrains to gasoline.

Fiat Chrysler (FCAU) and Peugeot should see improved business profiles with their pending merger, Fitch said. “The combined entity will have significant scale, strong brands, and wide product and geographic diversification,” they said.

Meanwhile, Renault’s deteriorating profitability and cash generation “could be exacerbated by sustain investment and lower dividends from Nissan,” the analysts said. “Renault’s alliance with Nissan is uncertain but provides it with capacity for substantial economies of scale and synergies, which we believe have not delivered their full potential.”

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