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Where Are We in the Auto Cycle?

In this week's episode of Industry Focus: Energy, host Nick Sciple talks with Motley Fool senior auto specialist John Rosevear about the state of the auto industry today. Tune in to learn where we seem to be in the auto cycle, according to a few contradicting indicators; the ultimate resolution of the UAW strike and what it means for GM (NYSE: GM), Ford (NYSE: F), and the rest of the major U.S. automakers; why the proposed merger of equals between FCA (NYSE: FCAU) and Peugeot is happening and why it's likely to go through; what John will be watching in the auto sector in 2020; some updates on EV adoption and self-driving tech; and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Nov. 7, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, November 7th, and we're breaking down the latest in auto industry news. I'm your host, Nick Sciple, and today I'm joined by Motley Fool senior auto analyst John Rosevear via Skype. How's it going, John?

John Rosevear: It's going great, Nick! How are you?

Sciple: I'm doing all right! There's a big college football game on Saturday. Alabama, LSU. One vs. No. 2. I'm a little nervous. But I'm excited to do the show here with you today. I think we'll have a great show!

It's been a crazy year in auto news. We saw our first nationwide strike in the better part of a decade. Big global mergers being announced. At the same time, the entire industry is undergoing this huge generational shift in technology to EVs, autonomous driving, all those sorts of things. We're going to get into that a little bit later on the show.

But first off, the auto industry is notoriously cyclical as a business. We've seen a number of companies already report their earnings earlier this month. What have those recent earnings reports told us about the state of the current global auto industry today?

Rosevear: First of all, let's back up for some context. We all remember the recession of 2008, 2009. Auto sales came out of that and rose to this big plateau, where they've stayed fairly close to, with some erosion, but not a lot of erosion over the last few years. The takeaway here is, this is a very long cycle by historical standards. It's not headed sharply downward yet, but we're all wondering when that's going to happen. Depending on who you ask, there are some signs emerging. I know Volkswagen, in their guidance, said that they were expecting slowdowns in several parts of the world going into the end of the year and into 2020. They've done fairly well in China, despite a significant market correction going on there in mass-market automotive. In part, that's because luxury has remained somewhat stronger, and Volkswagen's Audi brand is among the leaders in luxury in China. But, there are worries about Europe. There are fewer worries about the United States, but still. If the overall economy here starts to slip -- as soon as consumer confidence starts to fall, auto sales fall as well. People don't buy new cars if they think they might have to go job-hunting in a year. Companies don't buy new cars if they think profits are going to shrink. We're all watching for signs of it. VW did say they do expect it. That's official guidance from them.

Fiat Chrysler gave guidance where they said they think their profits will be up a little bit next year from this year, but sort of steady as she goes. Much of their operating profit is driven by trucks and SUVs in North America. More than anything else, that's a statement of confidence that the U.S. market still has some life in it.

So, it's a mixed picture. Certainly nobody's expecting boom times anytime soon. A downturn is inevitable, history teaches us. There are a few signs of it in some places, and not so much in other places. But, if you're thinking of buying auto stocks, late in the cycle is not traditionally the time. [laughs] But, hey, there may be bargains out there.

Sciple: Maybe some of those manifestations of concerns, at least from management's point of view as it comes to the cycle, has been behind a little bit of what we saw earlier this quarter, in the past few months, the UAW's strike against GM. As I said earlier, off the top of the show, that's the first national strike we've seen for the better part of a decade. Lasted 40 days, September 16th to October 25th. Very, very long for a strike. A national strike at all is abnormal, and then one to extend over this long of a period, obviously very significant. How is GM holding up after the stoppage? What are things looking like in relations between the company and the UAW today?

Rosevear: GM said that they expect the strike to cost it something like $3 billion. In the third quarter, it cost them $0.52 a share in adjusted earnings, it cost them about $400 million in cash flow. It cost them about $3.3 billion in revenue in North America because they book revenue when they ship vehicles to dealers, and if the plants are shut down, they're not shipping vehicles to dealers. They think they can make up some of that production by year-end, but they did ratchet down their guidance for the full year, saying everything else is on track but the hole in revenue generated by the strike will bring everything down. That was not unexpected. On balance, GM's earnings report was positive, under the conditions.

But, then, what did they get for that? You look at the deal that they cut with the UAW, which has been approved by workers. The UAW got almost everything it wanted except the really big thing, [laughs] is probably the best way to put it. GM wanted to close some factories. GM needed to close in factories. The workers, of course, don't like that. They don't want factories to close. The workers also wanted a shorter track from entry level to the top wage. They wanted a path for contractors to become full-time employees. They wanted to hold the line on their contribution to healthcare costs, things like that. They got all that. GM gets to close the factories. So, if we step back and say who won, well, everybody kind of won. It was worth it for GM to do this, probably, in the long term, but it hurts in the short term.

Sciple: So, GM's long-term costs of having to maintain these factories, they're able to get rid of those in exchange for giving the union note those higher wages they wanted. I believe the particular sticking point was healthcare costs. The union was paying well below market, and GM wanted to push those up closer to what the typical worker would pay. But, those are still well below the rest of the market. As we look to these other major U.S. automakers -- I think Ford is currently at the table with UAW -- do we get any signals from this deal as to what deals will look like with the other automakers? And, how much leverage might the industry have over the labor?

Rosevear: Ford has a tentative deal, which is to say, Ford and the UAW leadership agreed on it, and it's now out for vote to workers. Simple majority of workers, both regular hourly workers and what they call skilled trades, which are people like welders that are paid on a little different, higher scale. If they get a simple majority of both of those groups, the thing passes. Ford has, in recent decades, had a somewhat more cordial relationship with the UAW than GM and Chrysler, which is Ford's style, to some extent. Ford is aware that the UAW's sacrifices helped them avoid bankruptcy during the 2008, 2009 downturn. Bill Ford says that frequently. Bill Ford is the chairman of the board. So, once the GM thing wrapped up and the UAW turned its attention to completing the Ford deal, we did not expect great rancor. And sure enough, it only took a few days, and they came out with a deal that looks a lot like GM's, except that Ford isn't looking to close factories. There's one factory that will close. It's a small engine factory in Michigan. And they plan to offer every worker there either a retirement-style buyout or a new job at another plant that is just 15 miles away. So, it's not the significant disruption that we've seen with GM closing a factory that at one time employed 5,000 people in Ohio, and is just gone. This is a much smaller thing.

My sense is that the deal will probably pass. There's some grumbling, of course. There are always people that want more. But it does roughly fill out the pattern of the GM deal, otherwise.

Sciple: We've seen also from Ford recently interesting news when it comes to their EV strategy. They have touted, announcing a nationwide EV charging network, as well as a partnership with Amazon related to EV charging. What have we learned about Ford's broader strategy when it comes to EVs, and how are they building the company for the future?

Rosevear: Ford is laying a lot of groundwork ahead of something it's going to do later this month, where it drops its long-awaited Mustang-inspired electric high-performance crossover. [laughs]

Sciple: That's a mouthful.

Rosevear: Yeah. Basically, think of the Jaguar I-PACE, and now think of that with aggressive Mustang-inspired styling, and very good acceleration as an electric vehicle. This will be their first long-range electric vehicle. They are promising that, at least with an optional battery pack, you'll be able to get 300 miles of range or more. We don't know pricing. We don't know anything like that yet. I expect it to be more mainstream than a high-end product, given the amount of effort they're putting into things like the charging network and so forth.

This is the first of a series of electric Fords that will come out. Ford's whole strategy around this is to not roll out, "Here's a nice electric version of the Fusion," or the Explorer, or whatever. It's to use battery and electric vehicle technology to bring unique advantages. This is how they're going to sell it to their customer base, who, of course, are somewhat skeptical about all this. They showed this, "We're making an electric SUV!" Great. "It'll out-accelerate our fastest Mustang," or whatever. I don't know that that's true. But it'll be very quick off the line, and presumably as easy to use as they can make it, and as aggressively priced as they can manage. And then we'll see after that. They have an electric F-150 in the works. I expect it will have monster towing capacity. At that Specialty Equipment Manufacturers Association show, which is about custom cars and parts for custom cars, Ford showed off an electric Mustang it had built with a supplier, Webasto, with something like 1,000 horsepower, and, in an interesting twist, a six-speed manual transmission. Most electric vehicles use single-speed transmission. It's just simple and effective. You put the thing in drive and go. This was an interesting twist. Shows that Ford is thinking about, how might we do an electric Mustang, and what might it look like? This is pretty obviously a trial balloon, and so far, enthusiast response has been, "Hey, I want to try that!" So, they may be onto something. You may see an electric Mustang at some point.

They do have a number of electric vehicles in the works. We know they're also working on electric commercial vans and so forth. Near-term, to meet tightening European regulations on emissions, but also longer-term, they think this is where the business needs to go. Former CEO Mike Fields told me a few years ago that Ford is thinking in terms of, how do we lead our customers to electric vehicles? This is how they're going to do it. They're going to be fast, they're going to be sexy, the trucks will have huge capabilities, commercial vans will offer low total cost of ownership. They'll use electric vehicle technology, not just as, "Look, we're driving an electric vehicle," but to augment the specific selling points of different types of products and different segments of the market. That's their whole strategy. They aren't going to be first, they aren't necessarily going to have the highest end, but I predict they'll do pretty well. Ford, more so than some automakers, knows its customers really well.

Sciple: We've talked about in the past on this show how Ford and VW have cozied up a little bit when it comes to EVs, when it comes to autonomy. Are we seeing that continue to play out? Their strategies, as you describe them, sound very similar to how VW is approaching what they're trying to do on the EV side.

Rosevear: VW wants to sell EVs to everybody, or at least everybody it can convince to buy one. They're looking at huge volumes, mass market. This ID.3 that they are just now moving into preproduction, that they expect to begin shipping next year, if you squint, it's an electric Golf. And the Golf is, of course, their European mainstay car. It's the signature VW now. The partnership with Ford is interesting. What it gives Ford is a way to get, probably, an electric commercial van out to market in Europe pretty quickly using VW's architecture. Maybe before they can get a homegrown version ready, they can do this, they can get it out. It helps them quickly get into compliance in Europe. It starts to establish a market that they can back up with their commercial fleet expertise, their commercial fleet service, and so forth, and their own technology in terms of connectivity, which is another big thing Ford is working on right now, which will be a great interest to commercial fleets and so forth, knowing where all your vans are and how much fuel they're using, how much charge they're using, all this kind of stuff.

So, there is that side. On the self-driving side, of course, VW needs some help. Jumping into Argo AI was a good move for them. It brings Argo AI some more money, and it brings more scale to the program. They probably won't be bumping into each other too aggressively outside of Europe. Ford is obviously very, very strong in North America. VW is obviously very, very strong in Europe. VW is much stronger than Ford in China. It will be interesting to see how this plays out in terms of deployment, to the extent they're competing with each other. But Argo's program is fairly advanced. For VW to get in on that was a good deal. For Ford, using VW's platform to get an electric commercial vehicle out in Europe quickly, where the regulations are tightening rapidly, is also a good deal. We don't know exactly how much money is changing hands, but on paper, it makes a lot of sense.

Sciple: Yeah. Along those themes of getting in compliance with regulation, big, across-the-Atlantic partnerships among automakers, I want to talk a little bit about Fiat Chrysler. You like that transition there? Last time we talked about them, they had a proposed merger with Renault, trying to gain scale, gain some entry into EVs there. That didn't quite work out, partially due to the opposition from the French government. However, the most recent news out of Fiat Chrysler is that it's exploring a merger with another French auto company, Peugeot. What do we know about that merger so far when it comes to Fiat Chrysler?

Rosevear: It's probably going to happen. [laughs]

Sciple: There you go! [laughs]

Rosevear: No, no. [laughs] It's probably going to happen. They've signed a deal basically to figure things out as quickly as possible. That could become formal deal that would go to shareholders and regulators and so forth within a few weeks. There was talk that they could have this moving by the end of the year. Not done, but moving. It makes a lot of sense. Peugeot, Carlos Tavares is the CEO of Peugeot. He's s a bright leader. He's had a lot of success with Peugeot. But Peugeot has a structural problem, which is that it's heavily concentrated in Europe, and Europe's market is mature, it is very low-growth, there's a lot of competitive pressure, which doesn't help margins any, and the only areas of growth are SUVs, which is not an area in which Peugeot is traditionally strong. Peugeot would love to have more of a presence in the United States. FCA is obviously making a lot of money in the United States from trucks and jeeps. They have SUVs that they could bring to Europe in higher quantity. They have an SUV brand that could be adapted to highly efficient Peugeot platforms and so forth and used to generate sales and share in Europe. They fit together in a lot of different ways that seem to make sense.

Word about the French government, anyways, is that they favor this deal over an FCA Renault deal for various reasons, not all of which I'm clear on right now. The French government does not appear to be a likely obstacle here. They will, of course, have to deal with the Italian government, Fiat's traditional home. The German government, because Peugeot owns Opel, the German automaker that was a GM subsidiary for many, many years. They bought Opel. The German unions are very powerful and so forth. The state has an investment there as well. They may also have to deal with concern in the United States, because Peugeot has a Chinese investor, and that could be sensitive right now. But my bet is that this goes forward pretty much as planned as a "50/50 merger of equals." Carlos Tavares, Peugeot CEO, will be CEO of the combined company. John Elkann, who represents the Agnelli family that owned Fiat for decades, will be the chairman. Peugeot gets one more seat on the board than FCA. I think it's six and five for an 11-person board. But John Elkann will be chairman. That was how they split the difference on it.

What's going to happen in terms of factories and workers and product and so forth, we don't know yet.

Sciple: John, what is driving the urgency here from Fiat Chrysler? Obviously, we had this deal less than six months ago with Renault, then we've got another deal following up here with Peugeot. Seems to be very much a priority of the management of the company to get a merger of this kind done. What's driving that urgency?

Rosevear: Sergio Marchionne, who was CEO for years and passed away last year, felt for years that the auto industry needed to consolidate. There were too many factories that weren't making enough vehicles to be strongly profitable. The old rule of thumb in the auto industry is that an auto factory breaks even at about 80% of capacity. Capacity is defined as running two shifts at full speed five days a week. If you're below that, you may not be making money at that factory. There are too many factories that have been in that situation. He thought consolidation was important. Also, consolidation was important because it would give more scale to things like electric vehicles, to things like self-driving, to things like mobility businesses that may involve car-sharing and so forth. The more scale you can get on that, the lower costs you could have, the more comfortable margins you can have, the better you do in downturns and so forth, and you don't have to face these crises in downturns where automakers are on the verge of bankruptcy, as we've seen in the past, or even go into bankruptcy, as we saw the last time around. He felt in general that this was a very important thing for FCA to pursue.

And in the 10 years or so since the Fiat and Chrysler merger, they have had to triage their cash. They needed to pay down debt. What they did was invest in the most profitable products -- Jeeps, pickup trucks, things like that, luxury vehicles -- to generate cash flow so that they could stabilize the business and then look to things like future technologies and so forth. And the result is, now their debt is down. Their profits have been good. But, they're behind on things like electric cars and so forth. Whereas Peugeot has done quite well with small cars, with electric vehicles, and so forth. So, this gives FCA some of that technology. It gives them what they need to be compliant in Europe going forward with the tightening emissions regulations. They'll be able to figure that out with Peugeot, which was going to be an expensive problem for them by 2022 or so. They get that. Also, there are some region-specific things. Fiat sells small cars in southern Europe, among other things. Those cars have not been very profitable. FCA has said they're going to go to slightly larger cars that have slightly larger margins, but sharing architectures and engines and so forth with Peugeot to do that, where you develop the underpinnings of a car, you make a Peugeot-flavored car that you sell in maybe France and the Netherlands and places like that, and then a Fiat car that you sell in Italy and Spain, where the brand has traditionally been strong. There are lots of opportunities for things like that around the world.

Where the deal is weak is in China. Neither of these companies are big players in China. We await word of what they're planning to do there.

Sciple: John, I want to zoom back out again, look at the auto industry as a whole. We mentioned this major consolidation between Fiat Chrysler and Peugeot. That's going to make the fourth-largest automaker in the world. We've talked about labor conflicts, when it comes to closing factories. When you look out into next year, into 2020, what are you going to be following in this industry, and what should investors be paying most attention to?

Rosevear: On an industrial level scale, how well does this merger go? There may be more to follow. We've all been holding our breath, wondering if a wave of consolidation would happen in autos. We've seen some small moves, but this is a big one. We may see more. We may see Renault and Nissan become even closer than they already are, for instance. There are some players we look at like BMW and Honda. They're big companies, they're profitable, but they might do better if they were bigger companies. But, of course, with every company, you can point to, this is a reason they don't want to do it, and so forth. It'll be interesting to see how that evolves if the Fiat Chrysler Peugeot merger is successful, and starts paying benefits, and everybody seems happy. It was something of a surprise to the industry a decade ago that the Fiat and Chrysler merger was successful. They did a very good job with that. That's one thing I'll be watching.

Another thing we'll all be watching, of course, is the level of auto sales around the globe. As weakness shows up, as I said earlier in this show, it's very late in the cycle. We'll also be watching, obviously, consumer adoption of the electric vehicles. There's a wave of electric vehicles. A few of them have come to market this year. More are coming next year. How well are they selling? What kind of prices are they getting? How are our friends at Tesla doing? There have been some issues there. How are they doing in China and so forth? China's market is another wild card. It has slumped. Most of the global automakers are reporting lower profits from China, except in luxury. That's another thing we'll be watching. And, also, always the question, does anybody manage to bring an electric vehicle taxi fleet out? [laughs] Waymo has a few vehicles running around in Arizona without drivers on a very test basis with their car-sharing thing. We know work continues at GM's Cruise subsidiary toward a similar goal, which they want to deploy in places like San Francisco and so forth, soon-ish. We don't know how soon-ish. There are other players, including some that are in stealth mode, that may come into this. We don't know how all that's going to play out. But if anybody manages to do it, that will be very exciting in 2020, to watch that and see how that goes, if something that gets widespread consumer adoption, if it's profitable, and so on.

Sciple: Yeah, John. I think it'll be a very exciting year next year. When you look at the auto industry as a whole, this is a business that, over time, has been very incremental year over year. But we're seeing technological shifts forcing big step-change moves like these big mergers, converting whole lines over to EVs. That makes it an exciting time to be following this industry. Always exciting to have you on to share your knowledge of it! Thanks, John!

Rosevear: Thank you!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For John Rosevear, I'm Nick Sciple. Thanks for listening and Fool on!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. John Rosevear owns shares of Amazon, Ford, and General Motors. Nick Sciple has the following options: long January 2020 $50 puts on Tesla, long January 2020 $100 puts on Tesla, long June 2020 $100 puts on Tesla, long January 2021 $100 puts on Tesla, and long January 2021 $50 puts on Tesla. The Motley Fool owns shares of and recommends Amazon and Tesla. The Motley Fool has a disclosure policy.


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