In an industry notorious for lack of pricing discipline, fiscal year 2021 is requiring a totally different playbook from the ones we are used to. Historically, companies in the auto sector massively overproduced vehicles due to bloated fixed cost bases, which typically forced them to sell significant volumes at low or negative margins. However, COVID-driven production shutdowns combined with a global chip shortage have led to an inventory shock that has seen them lose these unattractive volumes. Thus, paradoxically, overall low inventories combined with production bottlenecks are leading to improved sector profitability as more robust pricing offsets lost volumes. For the same reason, used-car prices have reached new highs, allowing the automotive captive finance companies to likely report above-normal results, too.
That said, not all automakers are on the right side of this trend. Notably, the chip shortage is causing problems where (1) inventory was tight going into the chip bottleneck or (2) pricing power is weak. In this regard, German, Japanese and Korean OEMs are generally better positioned than U.S. and French counterparts. U.S. OEMs have historically done a better job of managing tight inventories and are therefore seeing the chip shortage erode profitable volumes. For example, Ford recently lowered its full-year guidance by $1 – 2.5 billion and may need to partly suspend production of the F-150 truck (its most profitable product). French OEMs like Renault, which have negative working capital, need to produce to generate cash flow and have limited pricing power—without it, they are unable to pass on costs and thus cannot overpay for the components that would otherwise allow them to produce more vehicles.
What can the industry learn from this? We think there’s an opportunity for the sector to stop overproducing and over-discounting vehicles. We are optimistic that pricing discipline will remain strong for years to come. That said, a year from now, when the industry has the capacity to produce at full utilization rates, it is likely, based on history, that some automakers will try to gain market share by pumping out volumes at discounted prices—with negative implications for sector profitability. This is the type of cycle we’re used to when investing in the sector and, quite frankly, it would concern us more than today’s production-induced volume hit. The current investment environment, however, requires an entirely different playbook—with less focus on volumes in favor of pricing power, inventory restocking timelines, and general flexibility to divert available components toward vehicles with higher margin contributions.