Automakers are likely to be among the businesses most acutely impacted by COVID-19. Over the next 12 months, most will likely rack up multi-billion-dollar losses that we will read about on the front pages of the financial press. However, accounting losses only tell half the story. Chief Financial Officers sitting in Stuttgart, Detroit, Fremont and Yokohama are likely more worried about cashflow and liquidity.
Consistent volumes are the lifeblood of automakers, with a new car produced every 60 seconds. When an assembly-line manager hits the stop button and the factory goes quiet, cash immediately starts walking out the door. Automakers typically have ‘negative working capital’ balances, that is, they generally pay their suppliers four to six weeks after parts are delivered, while receiving payments from dealers mostly up-front. This provides a nice cash boost as volumes grow, but reverses if volumes fall. With many cases of mandated stops to production due to COVID-19, many automakers have been required to cut multi-billion-dollar cash cheques to their suppliers, out of their own pockets.
Fixed costs, which can account for up to 50% of the final cost of a car, is the other major cash drain. Whether making cars or not, nearly all automakers have factories that still need to be maintained, large back offices and unionised factory workforces that are difficult to furlough without pay. Research and development (R&D) is another major ongoing obligation, particularly now, as there is a scramble to launch new electric vehicles to meet looming emission standards.
Other lesser-known liabilities include the complex web of dealer and supplier networks. Car dealers operate on wafer-thin margins, and in major economic downturns, often require floor plan financing directly from automakers (if bank finance dries up) and additional cash incentive payments to clear old stock and keep new volumes moving – Ford’s 90-day no payment plan and Nissan’s 84-month interest-free loans are examples of such subsidies. Guaranteeing the availability of parts can also consume considerable cash, either through the stockpiling of critical parts (as most automakers have done through COVID-19), or direct cash loans required to keep smaller suppliers afloat.
Finally, the large finance companies attached to automakers can also consume cash as customers default on loans and leases, and collateral and residual values fall along with prices in the second-hand market. Additional capital injections may be required in some cases to shore up liquidity and maintain access to interbank funding markets.
Since the start of the year, the MSCI World Automobiles & Components Index (US$) has fallen 25% from already very depressed levels and many automaker stocks have fallen even further.  This has left much of the sector trading below half of their book value, which is commensurate with the extreme distress seen in the global financial crisis (GFC).
There are, however, reasons for optimism. Unlike previous crises, some automakers enter this downturn with little debt and unprecedented levels of cash on hand, having prudently hoarded the bulk of profits for 10 years. BMW, for example, is carrying half of its market capitalisation in cash (€15bn) and behemoths like Toyota and Volkswagen are carrying US$35bn and €20bn respectively.  Even under the most drastic lockdown assumptions, the larger, better capitalised automakers should escape with little permanent damage to their business models and market positions. The V-shaped recovery emerging in China, also raises some hope that automakers may be able to recover volumes and margins faster than expected.
BMW and Toyota, with strong market positions, robust cash balances and GFC-style valuations, in our view, stand out as attractive long-term investments.
 As at 18 May 2020. Source: FactSet.
 Source: Company accounts and Morgan Stanley.
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Market Update - 19 May 2020
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