Sputtering Profits for Europe's Carmakers
At PSA Peugeot Citroën's Mulhouse factory in eastern France, 14,000 workers rotate in three shifts churning out Peugeot 307 compacts and 206 hatchbacks and convertibles. The assembly lines roll 22 hours a day to fill a three-week backlog of orders for the cars. Europe's economy may be in a funk, but consumers continue to snap up new cars. Industrywide, European auto makers' revenues rose 10% last year, to a record $360 billion.
But it's one thing to move the metal and another to turn a profit. Europeans may be rushing out to buy the latest in spiffy compacts, sleek sedans, and family vans, but they want a deal before they put up the cash. The result is a flood of red ink--and an ominous feeling in Europe's beleaguered auto circles that the pain is only just starting. "We're looking at a profitless boom scenario," says Gaetan Toulemonde, a Deutsche Bank analyst.
Prompting this bout of auto-related angst is the arrival of 2001 results. It's not fun reading. General Motors Corp.'s (GM ) German subsidiary, Adam Opel, ran up a $594 million operating loss for the year. At France's Renault, operating profit fell by more than two-thirds, to $140 million, while Italy's Fiat Auto is expected to report an operating loss of more than $400 million on Feb. 28. The Japanese and Koreans are losing money, too. And Ford of Europe, after a strenuous restructuring, is barely profitable.
To Detroit executives, this all sounds too familiar. Ford (F ), GM, and DaimlerChrysler (DCX ) have been propping up sales in the U.S. through profit-destroying discounts. Now the Europeans, who had shied from discounting before, are trying the same tactics, with similar results. Dealers are offering incentives even on brand-new models, such as the $12,600 Fiat Stilo compact launched last October. In Britain, Ford is offering 0% financing on models like the Mondeo. Analysts estimate European carmakers' operating profits shrank more than 10% last year. "They have to buy those sales," says Garel Rhys, professor of motor industry economics at Cardiff University in Wales.
And keep buying. Unit car sales in Europe are expected to slip as much as 5% in 2002, tracking a decline in consumer confidence that began a year ago as Europe struggles through something that's not quite a recession but sure isn't robust growth.
As a result, analysts are chalking down their 2002 estimates as well. Volkswagen's operating profit is expected to fall by 10% or more this year, as it discounts to drive sales. To steer some traffic into his showroom, Oliver Gloeckler, who heads the Autohaus Gloeckler VW dealership in Frankfurt, is now offering enticing package deals that include once-pricey options such as power steering, air conditioning, and electric windows. "These packages are cheaper than the extra equipment was in the past," he says, noting that they knock around $1,000 off the price of a new Golf IV, which starts at a none-too-pricey $13,100.
Adding to the squeeze, export markets are shrinking--particularly the U.S., where Germany's BMW and VW have racked up profits in recent years. Overall U.S. vehicle sales are expected to drop 10% in 2002, on the heels of an incentives-fueled boom. DaimlerChrysler, the European manufacturer with the greatest U.S. exposure, reported a $589 million net loss for 2001 on Feb. 6. It also issued a profit warning, saying it would miss its operating profit target of $5 billion for 2002 because of deteriorating market conditions.
Compounding the industry's woes, the European Union wants to promote competition by weakening manufacturers' control over their dealer networks. New regulations, expected to take effect in October, 2003, would still allow auto makers to pick their dealers. But those dealers would be free to sell multiple brands, anywhere in Europe. Politicians worry that such megadealers could muscle in on the small fry and drive them out of business through lower pricing. Auto makers wonder why the regulators are sticking it to them. Car prices in Europe have fallen 7% in real terms since 1996, according to PSA Peugeot Citroën Chief Executive Jean-Martin Folz. No matter: Brussels is adamant. The new EU rules could knock prices down a further 1% to 2%, analysts say, by reducing wide price differentials within Europe.
All these pressures are bearing down on middle-market players, such as Fiat, VW, and Renault. These and other volume manufacturers accounted for 70% of last year's sales of 14.8 million vehicles. Overall, investment firm Schroder Salomon Smith Barney estimates the operating margins of these manufacturers will shrink below 2% of sales this year. Even Peugeot, which reported a 25% rise in 2001 operating income, will be lucky to show a profit gain.
Carmakers with aging model lineups are finding it especially tough. Renault has a big handicap in 2002 because its main contender in the popular compact segment, the Megane series, which starts at $12,760 and includes the curvaceous Scenic compact minivan, is six years old. "That has reduced the line-up's attractiveness and had to be offset by marketing efforts," says Renault CEO Louis Schweitzer. VW's Golf IV, meanwhile, is showing its age. For years the most popular car in Europe, the Golf is seeing its sales slip as it enters the last year of its model life.
Bringing up the rear are Fiat (FIA ) and Opel. The companies teamed up in 2000 to cut costs by combining parts purchasing and developing common platforms. But the big benefits of their joint efforts will not materialize until 2006. Meanwhile, they are attempting to slim down further. Fiat said in December it would close 18 factories, shed 6,000 jobs, and sell some assets. Opel announced plans in June to pare back output by 16% and cut thousands of jobs. Its powerful unions, however, have put up fierce resistance. After fits and starts, negotiations between Opel's management and the unions resumed on Feb. 8. Analysts say the two marques' difficulties may spur the next big deal: the sale of Fiat Auto to GM. The U.S. auto maker acquired a 20% stake in the Italian carmaker in 2000, and the Fiat group has an option to unload the rest.
There is a silver lining to the cloud hanging over the industry. Analysts and car executives believe the profit squeeze will give them the excuse they need to slash away at production capacity, which exceeds demand by at least 15%. "There's still a lot of room for cost-cutting and rationalization," says Klaus Martini, head of European equities at Frankfurt fund manager DWS. And room for more pain, more discounting, and more red ink.
By Christine Tierney, with Andrea Zammert, in Frankfurt