European Automakers – Trade War Woes Add Pressure on Bonds

Trade war fears have dominated the headlines recently, but European automakers already face other serious headwinds. We believe bond investors should tread warily in this sector.

Potential Tariffs a Serious Threat

Leading European auto manufacturers are getting caught in the crosshairs of global trade wars. Concerns have mounted that the US might slap a permanent tariff on EU-produced autos. Although we see this as a low probability, it would have a serious adverse impact on European carmakers. In our view, Aston Martin and Jaguar Land Rover could be hit hardest, because they have no production facilities located in the US, one of their key markets. But we believe US tariffs could severely shrink the cash flows of the larger EU manufacturers too.

Potential US tariffs on Mexico are a further threat. This is another low-probability but potentially damaging scenario, as all German carmakers have assembly plants in Mexico that ship vehicles to the US. In fact, BMW just opened its first plant in Mexico on June 6 this year. We expect tariff risks will remain elevated while President Trump is in office. This unpredictability in trade policy is a problem for all companies that have a global manufacturing footprint, but the auto industry is amongst the most seriously impacted.

Meanwhile, risks have been mounting in several other directions. Credit spreads of the main auto companies have recently narrowed, after widening earlier in the year, which warrants caution. Leading European carmakers will likely continue to face negative fundamental headlines on a variety of cyclical and secular issues.

  • Onerous European Emission Regulations—Regulations on emissions in Europe will tighten considerably in 2020/2021, which will be a drag on profitability owing to added content and an adverse mix of hybrids/electrics. There is considerable uncertainty about the customer’s willingness to pay for vehicles with lower emissions and/or better fuel economy. Longer term, the outlook will become even more challenging as the European Union recently passed legislation to further reduce emissions in 2025 and 2030. We are concerned that governments will not provide enough carrots or sticks to encourage the necessary customer adoption.