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Analysis

With Change At Its Doorstep, The Industry Will Evolve Or Falter

Sat, 09/01/2018 - 16:19

The Mexican automotive industry enjoyed undisrupted growth in light-vehicle production, exports and sales in the domestic market from 2010 to 2016. However, 2017 was a breaking point. Starting in the second half of the year, sales began declining, reaching a total of 1.53 million units. Compared to 2016, this represented a reduction of 4.6 percent. In Mexico Automotive Review 2017, Guillermo Prieto, Chairman of AMDA, said that the one plausible scenario for the industry was to end the year with a 6 percent growth rate. The most pessimistic expectation was for sales to plunge 17 percent compared to 2016. The 4.6 percent decrease fell in-between and it still represented growth of 13.2 percent compared to 2015.
In terms of production and exports, however, the country continued to deliver stronger results, with a total of 3.93 million units manufactured and 3.25 million units exported by the end of the year. This represented an increase of 13.5 percent in production and 17.5 percent in exports. Volumes are still expected to increment in the coming years as automakers such as Audi, Mercedes-Benz, INFINITI and Kia continue to ramp up their operations while others such as BMW and Toyota bring new operations to the country. Nevertheless, changes in global demand are also expected to decelerate Mexico’s rise as an automotive powerhouse.
PERIOD OF STABILIZATION
Until 2016, industry experts expected the market to reach the 2 million-unit mark in terms of domestic sales by 2020. However, the downturn in sales has colored the picture significantly, moving the 2 million mark further down the line. Although not as exciting as growing at double-digit rates year-on-year, industry leaders still see a strong market in Mexico and urge other players to not see this as a catastrophic turn of events. “Domestic sales are not falling, they are just decelerating. Moreover, Mexico is not the only market going through this process,” says Gerardo San Román, Head of Latin America at JATO Dynamics.
The US, Mexico’s main export market and the second-largest automotive market in the world, saw a 1.7 percent contraction in its domestic sales by the end of 2017, going from 17.55 million units in 2016 to 17.25 million units the following year. Interest rates for vehicle financing are rising, as are gas prices and after years of continued growth, the US market is also stabilizing. Guido Vildozo, Senior Manager, Americas Light Vehicle Sales Forecasting of IHS Markit, expects the US will end up at yearly sales of 16.5 million units in due course.
“Mexico has the potential to reach yearly sales of 2 million units but not in the short term,” says San Román. To understand this, two factors must be considered in Mexico’s domestic development. First, in an effort to boost vehicle sales as much as possible, the financing market implemented an aggressive strategy to spur new-vehicle purchases. In 2010, only 49.8 percent of all light-vehicle sales were financed. By the end of 2017, that number had risen to 71.1 percent.
Although this is not a bad sign and it is in fact a key factor in ensuring continued growth in the industry, banks achieved this by elongating financing plans to the point where now clients can find loans of up to 72 months. “By enabling this, companies are extending repurchase terms and disrupting the sales cycle,” says San Román. “We are finally noticing the effects of this strategy; the market cannot sustain such growth levels indefinitely and that is completely natural.”
The second factor is the fallout from Mexico’s presidential elections. The market’s sales decline continued into 2018. As of July 2018, the market had seen 14 straight months of negative results. Between January and July 2018, the market sold 795,011 units, which compared to the 865,161 units from 2017 represents a contraction of 8.1 percent. Many industry participants attribute the negative results of the first half of 2018 partly to the elections on July 1. Due to the uncertainty caused by the campaign of now President-elect Andrés Manuel López Obrador, some customers put their purchases on hold until getting more clarity regarding the future of the country.
“Dealership visits have fallen in the past few months,” Carlos López de Nava, Director General of Grupo Alden, said prior to the election. “To boost confidence among potential buyers, some brands are offering their clients unemployment insurance to protect them for a few months should they lose their jobs because of the elections.”
Consumer confidence also was shaken during the first half of 2018 and inflation rates were on an uphill climb since January 2017, reaching a peak in December 2017 of 6.77 percent. However, the country’s economic situation has somewhat stabilized, returning inflation to 4.81 percent as of July 2018.
The market expects stronger results now that the election is over and some even suggest stronger results compared to 2017 due to the low numbers registered during the second half of that year. “The ideal scenario would be to stop further drops in demand and reach approximately 1.48 million by 2018 and an equilibrium point of 1.5 million units by the end of 2019,” says Guillermo Rosales, Director General of AMDA.
A NEW MARKET REALITY
In terms of production, Mexico was expected to surpass the 5-million-unit mark once all new OEM investments arrived to the country and started production. This would take the country from its current position as the seventh-largest light-vehicle producer to sixth, overtaking India. However, Vildozo, expects the country will not move past production of 4.1 million units due to the changes that some companies have made in their production plans.
In December 2017, Ford announced that it would move its production of Fusion out of Hermosillo, Sonora, to China by 2020, which according to Vildozo represents approximately 400,000 units. Meanwhile, FCA disclosed in January 2018 that its production of RAM would move out of its plant in Saltillo, Coahuila, to Michigan after CEO Sergio Marchionne said it was an error to move RAM production to Mexico. The company will spend US$1 billion on the move and Vildozo says that makes another 200,000 units that will no longer be manufactured in Mexico.
These moves are not the only concerns. Traditionally, Mexico has been a compact-car oriented production hub, which was fine as long as demand supported these units. But consumer preferences are changing and the world is becoming a light-truck intensive market. The US, Mexico’s main export market, is now favoring larger models that are not normally produced in Mexico. The shift in environmental policies in the US after it abandoned the Paris Agreement and announced a revision of the emissions-standard goals applied by the Environmental Protection Agency during President Barack Obama’s administration are contributing factors.
“Mexico will have to compete against the rest of the world to maintain its share in a relatively flat market,” says Vildozo. Its capability to do so, however, will depend on how willing companies are to shift their existing platforms in Mexico. Some manufacturers, such as Honda and FCA, already manufacture larger models in the country. Toyota, on the other hand, shifted its production plans for Guanajuato to produce Tacoma pickups instead of the previously scheduled Corolla. But not all companies are responding in an equal fashion. “Ford, for example, canceled its manufacturing investment in San Luis Potosi because it saw there was no point in producing 400,000 passenger cars if the US would not take them,” says Vildozo.
It will take some time before the market stabilizes to its true levels but there are already signs of deceleration in the manufacturing market. Between January and July 2018, production numbers reached 2.25 million units, which were only 0.1 percent above the results from the same period in 2017. Exports, however, remain strong with an increase of 8.1 percent between January and July 2018 compared to 2017, even without Nissan’s export numbers, which the company stopped reporting in April 2018.
DOORS CLOSE, WINDOWS OPEN
Overall, 2017 and 2018 have been challenging years for an industry that has been a cornerstone of Mexico’s economic development. Companies maintain business as usual but there is a lingering concern regarding what might happen with NAFTA once negotiations are over. Talks were originally supposed to end before 2018 and when that did not happen, they were supposed to conclude before the presidential elections in Mexico to avoid differences of opinions between the current and the future administrations.
An agreement has not yet been reached, however, and although there is optimism regarding a potential deal between Mexico and the US regarding rules of origin and salary policies, there is also discrepancy between what the government is willing to compromise and what the industry is demanding. Early in August 2018, negotiators said conditions were favorable to finalize discussions before the end of the month and sources assured Mexico and the US were finally seeing eye to eye on some thorny subjects. However, this was quickly dismissed by Fausto Cuevas, Director of AMIA, who said there was still no agreement between both countries. “Nothing has been accepted and nothing has been confirmed,” he said during a press conference regarding advances in the negotiation.
On a positive note, countries are still negotiating and there is disposition from all three sides to reach an agreement soon. Furthermore, after becoming president-elect, López Obrador appeased investors and the industry in general when he showed willingness to keep the negotiations moving forward and aligning to what the previous administration had put on the table.
While NAFTA talks have been slow, Mexico has been very active in promoting free trade and expanding its opportunities beyond North America. “Mexico has not been quick enough to consider other destinations, such as Africa or Eastern Europe, and to find ways to compete against manufacturing hubs like Morocco, Turkey, Romania, Poland and Hungary,” says Vildozo. “Understanding how these countries export to other regions is critical for Mexico to be more competitive and to diversify its operations beyond NAFTA.”
The country appears to have gotten the message and is now keeping track of potential trade opportunities. Mexico was the first to ratify the CPTPP, followed by Japan and Singapore. All three countries are urging the other eight members to ratify the agreement and start opening barriers for more opportunities in automotive and other industries. “CPTPP demonstrates the commitment of its members to open markets and to establish greater economic integration in the Asia-Pacific region,” says Yasushi Takase, Ambassador of Japan in Mexico. “CPTPP will enhance trade and business opportunities for the Mexican automotive industry and help bolster the region’s value chain.”
Mexico has also pushed to strengthen trade lanes with its Latin American neighbors, promoting further integration with the Pacific Alliance and Mercosur, the two main trade blocks in the region. The goal is to eliminate trade obstacles, bring more countries to these alliances and attract investment to all countries involved thus elevating the region’s overall competitiveness. “Mexico is ready, willing and able to compete in the global market. The country has been capable of exporting to the US, which has been one of the most competitive markets in the world along with Europe for more than 30 years,” says Vildozo.