Japanese Auto Analysts Predict Global Industry Restructuring

A new report by Goldman Sachs Japan Co. foresees a major structural downturn over the next two or three years as demand dwindles, the product mix worsens, plants close, capacity shrinks, earnings decline and some auto makers fail.

The problem, in brief, has become too much supply and too little demand, the report says, noting “restructuring is likely to be a global industry focus over the next two to three years.”

Goldman Sachs Japan analysts believe “global auto demand exceeded sustainable levels by 10 million-15 million vehicles” in recent years. Given worldwide auto sales of about 70 million units annually, they conclude production decline could be as high as 15% to 20% of peak output.

Production cuts already announced, including 2 million units in Japan, 2 million in the U.S. and 1 million in Europe, are less than half of what is needed to align present capacity with future demand, the report says.

Based on annual capacity in the average plant of 400,000 units annually, the analysts calculate roughly “three auto makers would have to go out of business or 50 auto plants around the world would have to be shut in order to reduce output by 10 million-15 million vehicles” as demand declines to more normal levels.

Goldman Sachs Japan sees product mix continue to shift to smaller cars, not only because of increasing fuel costs and tighter carbon-dioxide emissions standards but also because of growing demand in emerging markets.

Sales in these regions are on track to exceed that in the main industrialized countries, marking “a major turning point in the structure of global auto demand.”

Large producers such as Toyota to be hurt by global volume declines, deteriorating product mix.

In the U.S., a Goldman Sachs analyst estimates excessive demand has been 4.5 million units above stable levels for the last three years, driven by easy financing that exaggerated consumers’ real purchasing power.

Until the current global economic crisis hit, the “drive now, pay later” pitch to car buyers in other advanced industrial countries accounted for 60% to 70% of vehicle sales routinely being financed.

The same kind of easy credit steadily spread to emerging nations, as well, with the noticeable exception of China where most buyers pay cash.

Goldman Sachs suggests government bailouts now under way or under consideration in the U.S., Canada, Australia and a number of European countries clearly indicate “the auto industry is one where economic principles do not necessarily rule.”

“Government support will encourage industry restructuring, including the normalization of capacity and changes in product lineups and sales structures.”

In particular, the study foresees a third restructuring of Japan’s vehicle production, with output dropping 11% year-on-year to 10.5 million units this fiscal year and an additional 5% to 9.9 million units in the next fiscal year ending March 31, 2010.

This would be 27% below the peak reached in the fiscal year ending March 31, 1991. Japan’s first restructuring was in fiscal 1993-1994, followed by another in fiscal 1999-2000.

Analysts consider “another revolutionary cost improvement program very likely.” Specifically, they expect a program rethinking the entire cost chain, “including the elimination of excess design steps and more extensive sharing of components across models.”

They cite as one example the positive impact of Toyota Motor Corp.’s 3-year CCC21 program that began in July 2000 aimed at reducing overall costs, including those of products made in-house.

One target was a substantial cost reduction from outsourcing 170 components that accounted at the time for more than 90% of total purchases. Working closely with suppliers, starting at the manufacturing design stage, Toyota realized billions of dollars in cost savings.

But today, as Japanese assemblers start to suffer from low operating rates, Goldman Sachs analysts say auto makers likely will change their purchasing strategies and move back in-house the output of many products previously outsourced.

To the rhetorical question of which Japanese auto maker can handle structural change most easily, the reports says the pursuit of a compact-car strategy should limit the damage to Suzuki Motor Corp.

In contrast, Toyota and Nissan Motor Co. Ltd., with large investments in specialized facilities and producers of everything from compacts to large, premium-priced vehicles, are likely to be hurt both by volume declines and a deteriorating product mix.

The Goldman Sachs study forecasts global automotive demand will begin growing steadily again in three to five years. However, it notes the industry average return on earnings already has tumbled from a peak 13% reached in 2007 to an estimated minus 5% in 2009 and expects profits will remain depressed.

The authors emphasize industry consolidation and restructuring will be painful, with earnings remaining at historic low levels for the next two to three years, and “doubt any auto maker will make it through the downturn unscathed.”