In addition to the mounting cyclical challenges confronting the US automotive industry after years of strong growth, automakers and suppliers also face an uncertain future made up of rapid technological change and the potential full-scale realignment of the personal ownership business model.
This paradigm shift, which will become a reality in the not-so-distant future, adds layers of complexity for management teams and investors as the industry battles the challenges of the auto cycle in the short term, while positioning to win the auto 2.0 war.
We see two significant disruptions to the automotive ecosystem likely to come to fruition within the next ten years - electrification, as well as ride sharing/autonomous technology.
Electric rise pressures auto balance sheets
Electrification will play a key role in changing the automotive landscape as the industry begins to move away from the internal combustion engine (ICE) and towards EVs, particularly battery-electric vehicles (BEVs). While EVs represent only a small fraction of the current market, sales are expected to grow at a meaningful rate, which will require significant investment from automakers and suppliers.
The global auto industry plans to spend in excess of $250bn to develop more than 200 electric models globally by 2023, while close to 30% of global new car sales will be EVs by 2030 - with China driving the majority of the growth.
As battery cost and range appear to be the major limiting factors at this point, we believe full BEV adoption could occur more quickly if battery technology improves and costs decline faster than expected. In fact, some analysts believe EVs can achieve total cost breakeven with conventional cars in less than five years.
This generational change in powertrain technology will impact original equipment manufacturers and suppliers in several ways. First, the shift to hybrids and ultimately BEVs will require considerable capital and likely pressure returns in the early lifecycle of the programs. The pressure on capital and returns makes it imperative the industry maintains strong balance sheets and healthy liquidity.
Next, there is downside for suppliers of ICE-specific content, including exhaust, fuel systems, transmissions and engines. However, electric vehicle-specific content, including battery cells and pack, electric motor and drive, as well as power electronics, could provide additional revenue opportunities. Finally, it remains unclear how quickly consumers will adopt EVs and how quickly battery costs can come down, highlighting risks of early investments in this capital-intensive industry.
Automobile ownership could fall significantly
Aside from electrification, advancements in ride sharing and autonomous technology could fundamentally reshape the consumer's relationship with the automobile.
Vehicles in the US sit unused about 95% of the time and are inefficient when they are used - as less than 30% of the energy from fuel is used for propulsion. If these inefficiencies can be reined in, driverless electric vehicles designed for shared transportation service in the US could reduce out-of-pocket and time costs by 80% - from $1.50 per mile to $0.25.
A network of autonomous shared vehicles would also offer increased access to transportation, particularly in emerging markets, while expanding the potential pool of users and total miles driven. Since these shared autonomous vehicles are able to operate continuously throughout the day, utilisation rates will increase significantly, limiting the number of total units required.
As the service becomes cheaper and more reliable, consumers, particularly in urban centres, may ultimately choose to forgo personal vehicle ownership. These factors could ultimately result in a headwind to vehicle sales volumes, as miles are spread across a smaller and more efficient global car parc. While autonomous driving is expected to have little impact until 2030, this could rise to more than 20 million vehicles by 2040.
This paradoxical outcome of total vehicle distance increasing as unit volumes decline has the potential to negatively impact players across the automotive value chain. While automakers of today generate revenue primarily through vehicle sales and financing, a future of lower production and increased commoditisation could shift the value to the companies owning the technology and the immense trove of data collected by the fleet. This explains why the major auto producers and suppliers are so invested in developing autonomous driving systems and related networks.
While it is much too early to pick the winners and losers in these emerging technology fields, the coming changes to the industry are also impossible for investors to ignore. The major global automakers and suppliers continue to employ a balanced strategy, investing in virtually all areas of the transportation ecosystem as the future begins to take shape.
However, the rise of technology has also prompted new competitors to enter the fold, including tech leaders like Apple and Google, which have the financial resources to get involved. We would expect the coming decades to present many successes and failures, new partnerships and investments, as well as emerging clarity around the future competitive dynamic in the industry.
John Smigelsky, vice president, investment grade credit research and Gary Stromberg, principal, high yield credit research at PGIM Fixed Income