February 2, 2012 3:06 am

Carmaking: in the slow lane

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A sector long seen as an engine of European industry looks increasingly shaky

Last summer, as Europe’s sovereign debt crisis gathered pace, Philippe Varin was sitting in his Paris office, studying disturbing figures from the field. The suave, steely 59-year-old boss of PSA Peugeot Citroën, the continent’s biggest carmaker after Volkswagen, was seeing sales slide for some models – notably the subcompact 207.

Demand for the car had surged in 2009 and 2010, when France and other European countries introduced “cash-for-clunkers” subsidies to bolster the sector after the banking crisis devastated car sales. Scrappage schemes had prompted buyers to trade in old models for small and cheap cars, keeping producers busy making models such as VW’s Polo, Ford Motor’s Fiesta and Fiat’s 500.

cars

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But with these incentives long discontinued, the 207 was now one of the oldest in a brutally competitive segment. Peugeot’s customers, and some dealers, were pressing for unsustainably deep discounts to match those of other carmakers. Meanwhile, consumer confidence was evaporating in four of Peugeot’s biggest markets: France, the UK, Spain and Italy.

Mr Varin reacted fast. He cut production days at the four plants that make the 207 in France, Slovakia, and Spain. In October the company said it would cut 6,000 jobs and make €800m of cost savings, and that it was heading for a significant second-half loss. The share price dropped.

Peugeot Citroën was the first big victim of the eurozone crisis in the region’s carmaking industry. However, the profit warning presaged what is certain to be a dismal year for the continent’s mass-market industry. Ford Motor reported a fourth-quarter $190m loss in Europe last week; Fiat on Wednesday reported higher 2011 and fourth-quarter earnings, lifted mainly by its US Chrysler unit and sales in Brazil, but acknowledged its mass-market business in Europe had lost €500m last year. France’s Renault and General Motors’ European Opel/Vauxhall arm are expected to report sagging fourth-quarter earnings in coming days.

Europe’s flagging car market – sales fell 6 per cent year-on-year for the month of December and are forecast to fall again this year – has brought the industry’s problems to a head. But the root causes lie deeper, in oversupply issues plaguing a cornerstone industry always under scrutiny from politicians and the public.

Analysts are describing Europe as the sector’s “sick man”, a status held until recently by Detroit’s three carmakers, which restructured deeply during the crisis. “All the European carmakers are running against the treadmill, in some cases with increasing speed,” says Stefano Aversa of AlixPartners, the turnround consultancy whose clients include GM.

Executives warn of coming distress in the sector, which directly employs more than 2m Europeans and comprises some of the region’s biggest employers and exporters. With eurozone unemployment at a record high, at stake are much-needed jobs in a sector that in good times reliably provides them, but in times of crisis can become a liability.

PREMIUM MODELS: Luxury brands speed past industry woes to record sales

While the plants of Europe’s French- and US-owned volume car brands have been cutting production days, most of their German competitors are working at full capacity.

BMW, Mercedes-Benz, Audi and Porsche all saw their brand power and growing presence in emerging markets drive record 2011 sales.

Unlike Peugeot, Renault, General Motors or Ford Motor, who tailor their cars for drivers in Asia and Latin America, opting to build them there to save costs, most German premium cars are made in Europe. Luxury cars are easier to make in one place and then export because they are global products, with minimal regional tweaks. The margins they deliver are fat enough to cover shipping costs and tariffs.

The big four premium brands also like to build close to home because they are spending billions on new and commercially sensitive technology, such as lightweight carbon fibre.

Demand for luxury, extremely profitable cars is high. BMW’s 7 Series and Mercedes’ S-Class are selling at record levels in China, now the segment’s biggest market. Top-end sport utility vehicles, including Audi’s Q5 and Porsche’s Cayenne, sell well everywhere.

Because German products are in such strong demand – and are so globally homogenous – would-be Chinese drivers are in a global buying race that strengthens the brands’ pricing power. “Effectively, a Chinese consumer is competing with a European consumer and with a US consumer for a 7 Series,” says Stuart Pearson of Morgan Stanley. “BMW can sell to the highest-bidding customer because of their capacity constraints.” Premium carmakers also profit from the strength of the German market – the only big country in Europe where sales are still rising.

But in a business as cyclical as carmaking, even premium brands cannot afford to be complacent. BMW, Mercedes and Audi suffered early in the financial crisis, when the credit crunch wreaked havoc on their large leasing businesses in the US. Mercedes was too slow to cut its production to match falling sales.

Analysts warn that the Germans could be hurt by their growing reliance on China, especially if demand there cools. Serious turmoil in the eurozone would hurt demand for their products in Germany, and a squeeze on credit could dry up their sources of funds.

Sergio Marchionne, Fiat chief executive – also vulnerable to the euro crisis because of its exposure both to the troubled Italian economy and to small cars – recently likened the scene to orphans jostling for food. “If you don’t see growth, whoever’s left at the table is going to be left fighting for scraps of food,” he told the Financial Times in Detroit last month.

Europe’s car industry did not heal itself during the financial crisis. Detroit’s producers closed dozens of plants between 2006 and 2009 and now have lean operations supplying a resurgent market. Asian peers have plenty of demand to keep them busy. But Europe is still saddled with capacity to make millions more cars than the market wants. Because of political and union pressure, too many high-cost plants have been kept open at home when growth and profits have largely moved overseas.

Worse, the billions of euros of aid extended to European carmakers in 2009-10 – including scrappage and the €6bn French bail-out of Peugeot Citroën and Renault – may have merely postponed much-needed restructuring.

When the US Treasury ushered GM and Chrysler through bankruptcy, it required them to produce crisis-proof business plans and downsize operations. Paris, by contrast, told Peugeot Citroën and Renault to keep plants open as the price of emergency loans.

While GM, Ford and Chrysler closed dozens of plants, in Europe just two factories have shut since 2008: Opel’s in Antwerp and Fiat’s in Sicily. Plants in the countries at the heart of the eurozone crisis – notably France, Italy and Spain – are looking especially extraneous, as bosses search out cost savings. However, in a business that disregards borders, operations in countries from the UK to Slovakia and Romania are vulnerable too.

. . .

Three years on, scrappage programmes also look like an un­sustainable quick fix. They cushioned producers from falling demand and trained European consumers to expect big discounts, especially for small cars. According to Jato Dynamics, an industry research group, dealers and manufacturers between them offer incentives on mass-market cars that average one-third of their suggested retail price.

Arthur Maher of the LMC Automotive consultancy estimates that the European industry now has the capacity to build 10m more cars annually than the market wants – equivalent to 20-25 car plants. Given the forecast severity of the continent’s economic downturn this year, he expects more redundancies. Some carmakers, he says, are postponing investment.

Arndt Ellinghorst of Credit Suisse says: “Weak European mass-makers will get weaker, and balance sheets and liquidity will become a huge issue. Banks are more selective about who they give money to.”

To be sure, Europe’s carmakers will find some relief in emerging markets. But stripped of overseas income, most – except possibly VW, bolstered by its large scale and luxury brands – make only slender profits or lose money.

In any other industry, such losses would have led to rationalisation, entailing some business failures and a return to profits for the survivors. But Europe’s car sector, to its short-term benefit and long-term detriment, is treated by politicians and family or state shareholders as a special case – an employment-generating scheme.

Peugeot’s Mr Varin earned his reputation in steel, an industry like carmaking saddled until recently with overcapacity. At Corus, the Frenchman presided over a deep restructuring and its sale to India’s Tata Steel.

Peugeot Citroën: Exposed
Where it is: carmaker most exposed to Europe’s structurally declining market is widely seen as likeliest candidate for consolidation with a rival
Philippe Varin, chief executive, says
“we will be in significant loss in the second half of the year, with a negative cash flow”

Renault: Under pressure
Where it is: Renault is cushioned by partnerships with Nissan and Daimler but, 15 per cent state-owned, it faces pressure to preserve jobs in France
Carlos Ghosn, chief executive, says “we know that the first quarter of the year is not going to be good ... the order bank has been going down”

Fiat: Hurting at home
Where it is: Fiat’s core European small-car business is lossmaking. Chrysler and Brazil, where it is market leader, are keeping the Italian carmaker afloat
Sergio Marchionne, chief executive, says “best prognostication” for Europe until 2014 is “flatline” growth, and he is seeking to form an alliance

GM: Boxed in
Where it is: restructuring at Opel, GM’s European unit, has led to job cuts (with hints of more to come) and a plant closure. Low emerging market presence
Dan Akerson, chief executive, says third-quarter losses of $292m in Europe are “not sustainable”. Rumours of an Opel sale persist

Ford: Discount pressure
Where it is: recording bumper global profits but losing money in Europe, where it faces pressure to discount. Looking at shedding temporary staff
Alan Mulally, chief executive, says “a deteriorating external environment impacted most of our automotive operations outside of North America”

VW: Solid earner
Where it is: VW’s huge global volumes, trucks, and sales at Audi and Skoda make it Europe’s least at-risk mass producer. But not immune to slowdown
Martin Winterkorn, chief executive, says “2012 will be substantially harder, above all in Europe, and especially in highly indebted countries like Italy”

Under Mr Varin, Peugeot Citroën, has diversified away from low-margin small cars and western Europe, launching higher-priced products such as Peugeot’s stylish RCZ roadster or Citroën’s upscale new DS line, which it plans to build in China. Peugeot last year sold 42 per cent of its cars outside Europe, up from 39 per cent in 2010.

But since announcing plans to cut jobs, Mr Varin has had to tread gingerly. Although Peugeot Citroën long ago repaid its bail-out loan, plans for its French plants are under close scrutiny in an election year. When a French newspaper published a company document suggesting Peugeot might close the plant in Aulnay on the outskirts of Paris that makes Citroën’s C3 supermini, it faced accusations from some pundits and politicians of “delocalisation”.

Speaking to a committee in the French national assembly in December, Mr Varin took pains to explain that, for a global carmaker, investing overseas was not a zero-sum game. “I find it normal to have 1,500 people in São Paulo who work on models with specific features that must be adapted for this country,” he said. He pointed out that Peugeot Citroën made twice as many cars in France as it sold there.

Because closing French plants is politically taboo, Peugeot has sought to keep them busy by producing higher-margin models such as the DS. It has also streamlined operations at underused factories in a process it calls compactage.

Similarly, Renault – while investing in plants in low-cost regions such as Morocco – has concentrated production of higher-margin products such as electric cars in France.

. . .

Analysts have long argued that France does not need two carmakers. But the industry’s symbolic status as a repository of national self-worth – combined with the prevalence of powerful family and state shareholders – have hampered mergers.

Thierry Peugeot, Peugeot Citroën’s chairman, in 2009 signalled his openness to alliances but set conditions – notably that the family remain the dominant shareholder. After talks with Fiat, the company failed to reach a deal because of disputes over control and other issues. Mr Varin discussed a cross-shareholding alliance with Japan’s Mitsubishi in 2010 but scrapped talks, claiming they might hurt his company’s credit rating.

In this context he has one of the least enviable jobs in European industry today. “If you were an adviser to Philippe Varin, it would be difficult to tell him what to do differently,” says Stuart Pearson of Morgan Stanley. “There are constraints politically, from the family, and financially.”

Mr Marchionne of Fiat says he is still hunting for a partner to make small and very small cars, and recently forecast that the eurozone crisis would finally force rationalisation of operations. Last month he met Mr Varin at a dinner at Detroit’s car show, renewing speculation about a merger with Peugeot Citroën. The latter said afterwards that it was “absolutely open” to alliances with a rival, but that conditions were not yet right.

The French company last week tempered the gloom of its downsizing when it launched production of the new 208, a successor to the 207, at its plant in Poissy on the outskirts of Paris. It said it was investing €600m in France, and that the car confirmed its “deep commitment to its home country”. The 208 will feature super-efficient new engines.

But Europe’s oversupplied car market has no lack of good small cars. Analysts say that whatever Mr Varin’s assurances, the group will have to downsize on the continent and invest more overseas. “Eventually, Peugeot will shrink its industrial footprint in France, just as Renault has, and rely on lower-cost locations,” says Stephen Reitman, analyst with Société Générale. “That is inevitable.”

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