Article / 13 September 2017 at 10:00 GMT

Weekly Bond Update: Carmakers put the rubber to the road

Manager, Global Sales Trading / Saxo Bank
Denmark

  • Auto industry stable following crisis-era bankruptcies
  • China the key driver of Asian auto sales
  • EVs more than AVs are the key challenge for carmakers

Auto plant

Auto sector bonds remain pricey, but some companies still 
offer good value for money. Photo: Shutterstock 

By Althea Spinozzi

The auto industry has been quite stable in the past few years after the series of bankruptcies and restructurings caused by the 2008 financial crisis. As a matter of fact, US SUV demand has been growing robustly as lower oil prices support larger vehicles (and thus larger sales margins), and demand from emerging markets has been steadily growing as well.

China has been the key driver of Asian automobile volumes in recent years, and this is the main reason why many companies have looked to make large investments in order to increase production in the country. Ford and Fiat Chrysler have been investing heavily in Chinese plants, while Hyundai Wia and Toyota Boshoku remain the largest auto suppliers in the Asia-Pacific area.

Domestic auto demand in India has been also positive even though sales of vehicles have decreased due to the demonetisation of the large-denomination rupee last year. Regardless, India remains an important growth market for the auto industry as demand will be supported by planned economic reforms.

Other BRIC markets have proven to be more of a challenge for the sector. Auto demand has stalled in Russia and Brazil, for instance, as credit is hardly available and there is a gap between purchasing power and current market prices. Growth may resume in Brazil, however, as the government has introduced the Inovar Auto Program in 2012 which offers tax reduction incentives to encourage manufacturers to invest in local production. 

At the same time, auto sales may be forecasted to increase in Russia as almost half of the cars in the streets are more than 10 years old and Russia´s economy may grow again if oil prices recover and sanctions are eased.

In the meanwhile, automobile companies´ bonds have been tightening, and with Tesla´s recent new issue it is impossible not to look at the sector and wonder whether there is space for further tightening.

The Tesla bond (B3/B-) issued last month is among one of the most hotly debated new issues of the year. With a coupon of 5.3% and 2025 maturity, it returns a yield of 5.5% which is quite low for an eight-year single B bond considering that in other sectors this is a yield paid by high-yield bonds with 2022/2023 maturities. 

Investors feel comfortable holding Tesla bonds as the firm is renowned for its progressive technology and expects the Class 8 truck (to be unveiled on September 28) to be a bigger success than the market has anticipated.  

Tesla shares, 2015-present:

Tesla

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Source: Saxo Bank 

On the other hand, there is a risk that the Model 3 ramp-up could take longer than estimated, as well as the broader risk concerning a slower-than-expected adoption of electric cars by the public.

Even more conservative yields are paid by the largest automotive groups with Fiat Chrysler (BB/BB-) paying a 3.7% yield for the 5.25% coupon bond with a 2023 maturity and in the IG space, General Motors (Baa3/BBB) paying 3.33% yield for its 4.875% bond with a 2023 maturity. 

Even though Fiat Chrysler is a high-yield name with a weaker balance sheet than its peers (and fines from the EPA), the carmaker is being viewed with some interest as it owns many valuable assets that it could decide to sell in order to improve its current balance sheet. 

On the other hands, the better-rated General Motors has a strong business and with its Auto 2.0 plan the company will have an opportunity to grow with the popularity of self-driving cars.

The real question is whether current yields reflect the auto industry´s challenges when for companies in this space it is becoming harder and harder to keep up with technology and market requirements.

Pressure from western governments to restrict emissions and fuel consumption is increasing, and this is the reason why companies are investing heavily in various engine technologies such as electric, electric hybrid, diesel, and more. The problem is that nobody knows how the regulatory landscape is going to change and what specific technologies governments will encourage adopting in the future. 

Consequently, automakers could wind up putting capital into technologies that may not have a future.

Secondly, carmakers will need to diversify their product ranges further in order to satisfy growing demand from emerging markets. Because of the differences in infrastructure and purchasing power, there is a pronounced need for cheaper cars and the exploration of various alternatives in design and marketing for these regions.

We still haven't mentioned the shift to Autonomous Vehicles, a technology that will not be viable and able to drive revenues for another 10 or more years. As a matter of fact, the development of the technology itself will not be enough to bring self-driving vehicles to the street. Not only will new infrastructures and insurance mechanisms need to be put into place, but AVs will also challenge lawmakers as well. 

We could see the widespread adoption of AVs delayed by more than a decade given these hurdles. This is why it is important for carmakers to reassess their medium-term plans, identify their competitive edges, and capitalise on them. It is very probable this sector will be subject to substantial restructuring in the next decade as the needs of car producers merge with those of technology companies and suppliers.

Going back to the bond market, the sector is pricey at the moment and the future is uncertain, but there are still companies that just do it right.

Take, for example, Aston Martin. The luxury British automaker is at forefront of technology, yet it stays true to itself. As a matter of fact, Aston Martin recognises its high-end niche and has reached out to partner up with Daimler in order to build on it. For Q2 2017, the company reported record results due to global sales led by the DB11 model. 

Aston Martin's 6.5% bond (B3/B-) with a 2022 maturity pays a yield of 4.0%, offering 150 bps less the Tesla's 5.3% 2025 despite the parity of rating, Aston Martin is a proven name that is doing all the right things, and rising car sales will be supported if oil prices stay low. 

The only problem? The only problem? The bond is well bid and liquidity is low.

Aston Martin DB5


The legendary DB5: Aston Martin is a strong firm that knows its niche 
and has solid plans to boost growth. Photo: Shutterstock

— Edited by Michael McKenna

Althea Spinozzi is a sales trader at Saxo Bank

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