Blog

ECONOMY
June 06, 2019

US Automotive Sector—Trade War Impact

By Mike Borowske

For the better part of the last two years, Western Asset has held a cautious view of the automotive space. While there are positive attributes we can identify, such as the strong balance sheet and liquidity profiles of the major original equipment manufacturers (OEMs) and the collective management team experience in navigating market downturns, the industry has been under siege for the last 18-24 months. Crosswinds span a mix of secular, cyclical and technical factors, which include, but are not limited to: deteriorating industry fundamentals, the blowback from the imposition of steel and aluminum tariffs on Canada and Mexico, volatile raw material input costs, higher fuel prices, structural risks from new entrants and technological disintermediation, poor market sentiment and negative supply technicals.

The latest headwind now comes in the form of escalating tariffs on imports from China and Mexico.

As context around how this risk can impact the US automotive industry, it is important to note that the industry has historically accounted for roughly 3.0%-3.5% of total GDP and roughly 4.0% of the country’s total personal consumption expenditures (PCE). Moreover, there are 14 domestic and international OEMs operating 45 assembly plants in 14 states across the US, with a heavy presence in the South and Midwest—this supports more than seven million American workers with $500 billion in annual paychecks and $200 billion in federal and state taxes. Domestic OEMs also invest more than $20 billion annually in research and development, and help to transform future mobility by investing heavily in automation and electrification.

With this in mind, the impact of a full-blown trade war would severely impact an already fragile sector. For instance, industry analyses show that a 25% tariff would raise the price of an imported car on average by $6,875 and the price of a US-built vehicle by $4,400. Nationwide, if a 25% tariff were imposed, based on FYE 2017 industry sales, American consumers would be hit with an additional tax of nearly $45 billion. Separately, a Petersen Institute analysis projects nearly 200,000 job losses across the industry. In the event other countries retaliate, job losses could reach more than 600,000, or nearly 10% of the auto industry-related jobs in the US.

Simply put, tariffs of any meaningful size or consequence will result in a significant indirect tax on US consumers that has the potential to upend the existing auto sales cycle by reducing overall demand, raising unemployment rates in this sector (as a result of lower production rates), and threatening future investment in advanced engine technologies (hybrid/electric) and autonomous capabilities.

From a valuation perspective, the investment-grade (IG) and high-yield (HY) automotive sub-components were the worst performing subsectors in FYE 2018, as IG and HY spreads widened by 110 bps and 223 bps, respectively. On a YTD 2019 basis, however, IG automotive spreads have rallied approximately 42 bps, primarily on the back of better-than-expected 1Q19 earnings results from Ford, while HY automotive spreads are 7 bps wider given recent weakness in Tesla and Tenneco senior unsecured notes.

While we are cognizant of the fact that there may be additional spread pick-up or carry opportunities available in today’s market, we believe there are simply too many exogenous factors present at this time to warrant a more constructive view and positioning in broad market portfolios. In line with our defensive view, we maintain a preference for companies with strong balance sheets, large liquidity buffers, disciplined capital allocation policies, flexible cost structures and solid free cash flow generation capabilities to help manage through a more challenging operating environment.

© Western Asset Management Company, LLC 2019. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK and EEA countries as defined by the FCA or MiFID II rules.