Autos & Shared Mobility
Diesel denial? Hopes rest on another government solution on Aug 2nd
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Europe
Industry View In-Line
Harald C Hendrikse, Victoria A Greer
July 25, 2017
OEMs are reportedly in talks with the German government to fix Euro 5 diesel emissions to avert outright driving bans. We think sales figures show the consumer knows better. Now, collusion allegations will make it harder for the government to support OEMs. We think the OEMs are in denial on diesel.
Automakers self-report collusion spanning 25 years, according to Der Spiegel: According to a 100-page filing seen by Der Spiegel in Germany, the five German OEMs (Daimler, VW, BMW, Audi, Porsche) are alleged to have met over 1,000 times in 60 committees spanning 25 years to discuss all manner of automotive content, suppliers, supplier costs, and even emissions technology. Der Spiegel highlights papers suggesting that these committees agreed to limit SCR AdBlue tanks to 8L, rather than the required 30-35L to meet emissions standards - saving the OEMs approx. €80 per car. Given the self-reporting, and the level of detail in the articles, we believe that on-going investigations by the German and EU cartel offices will remain a drag on the sector for some time - Der Spiegel claims that this could become one of the largest cartel cases in German corporate history. BMW, the only German OEM to comment on the report, denied any wrong-doing.
Three key risks from the collusion allegations: We see three key risks if the OEMs are found to have illegally colluded: 1) Significant fines - under EU cartel law, companies found guilty of collusion can be fined up to 10% of Group revenues (which would amount to €10-€20bn for the big three German OEMs) - in a worst case scenario, we think this would mean that some OEMs would have to raise new equity to maintain balance sheet strength, and that provisions could threaten dividend payments; 2) Loss of government support - against a backdrop of diesel risks, and European lawsuits, the OEMs have benefitted from German government support - if illegal collusion is proven, that political support may be at risk into the German election; and 3) collusion on fixing emissions systems, if proven, could change the debate on liabilities for Euro 5 and Euro 6 cars that don’t meet legal emission standards - previously, OEMs could simply point to their meeting the old European test standard.
German politicians coming to the aid of their auto industry supporting €100 software recall? To counter the risk of a Stuttgart Court diesel driving ban, OEMs have started to announce "voluntary" software recalls. Daimler last week said it would recall 3m cars across Europe (over 90% of affected Mercedes cars) at a cost of €220m, whilst Audi has announced a recall of 850k 3L and 4L TDI cars. Initial Stuttgart Court reaction was sceptical of the proposed solution, but a final decision is due Friday 28th July. After that, German Transport Minister Alexander Dobrindt has organised a Berlin conference on 2 August with OEMs to address the issue. This minister was quoted by Reuters last week as saying "driving bans are an ineffective tool for reducing pollution".
Proposed software fixes will be ineffective in improving Air Quality: In fact, with Stuttgart air pollution over twice the European legal average, and with ICCT quoting an average NOx emission for Euro 5 cars of over 1,110 mg/km vs a Euro 5 limit of 180 mg (now 80 mg), we think software fixes reducing emissions up to 20% are even less effective - with real world driving emissions remaining significantly above legal limits. With the cost of a software recall up to €100/car, and hardware fixes costing up to €1,500 per car, we are not surprised at the direction of car industry lobbying. 102m cars were sold in Europe in the 2009-2016 period, of which we estimate 55m-60m were Euro 5 and Euro 6 diesel cars with real world driving emissions well over legal limits.
Porsche joins Volvo in questioning the future of diesel at all: In contrast with the other German OEMs, Porsche CEO Blume was reported by Reuters last week as saying "Porsche's latest generation of diesel engines could be its last". This contrasts with recent statements from all the other German OEMs maintaining their diesel engine strategies, and further questions diesel residuals for consumers from here. On 12th July, Volvo cars CEO Hakan Samuelsson was reported by Reuters to have laid out a future for Volvo cars with no new combustion engine-only models post 2019, and an ambitious new BEV strategy. See Autos & Shared Mobility: Electric car - Volvo gets it (07 Jul 2017) . Clearly, Porsche and Volvo have a view on the limited future of diesel from here.
Consumers are not persuaded - diesel sales falling sharply, residuals also lower: Potential driving bans, diesel congestion charges and statements from Volvo and Porsche raise questions on diesel's future. European diesel sales have fallen very sharply in recent months, with German passenger car market share down at 38.8% in June 2017, and falling 500bps yoy across Europe's largest markets. A €3k greater diesel residual decline could lead to almost €100 higher monthly lease payments, or 30%. Why would consumers buy (highly monthly payment) cars that they know will be phased out after 2019 by many OEMs? When will OEMs reflect likely diesel residuals declines? (see -European Automotive Sector - European Diesel Compendium (05 Jul 2017)).
China NEV investments, Germany is stuck on diesel? China's NEV focus contrasts sharply with the latest German government efforts to avert diesel driving bans. See Autos & Shared Mobility: China NEV risks rising (17 Jul 2017). OEMs such as Daimler, VW, and Toyota have recently announced large investments in NEV capacity in China to allow them to meet NEV targets - building a large lead for China in next-generation auto technology. Meanwhile, in trying to save automotive employment, the German government is spending its time trying to save a technology that some OEMs are already abandoning. We question whether a better solution would be in Germany proposing an industry-friendly BEV technology development policy.
BEVs face a much lower hurdle without cheap combustion engine competition: Volvo's move also moves the goal posts for BEVs - instead of competing on cost with a cheap petrol alternative, BEVs will only compete with much more expensive hybrids. This could remove one of the many obstacles to BEV penetration that continues to haunt these products - further clearing the way for BEV penetration to move higher – see Autos & Shared Mobility: One billion BEVs by 2050? (05 May 2017). Previously, we highlighted advances in power chip technology that will improve BEV performance significantly. Our Indian auto analyst, Binay Singh, recently upgraded his India BEV penetration forecasts, raising our global BEV forecast in the largest future auto growth market, as further scepticism fades - India Autos & Shared Mobility: India EVs: Ripples for Now, Signals an Upcoming Wave (05 Jul 2017).
Conclusion - a long list of unknown liabilities: European OEMs are trading on low valuation multiples, and recent news again highlights the regulatory risks they face. Until such regulatory and structural issues can be addressed, and the costs of such changes can be assessed, we believe it will be unlikely for valuations to bounce sharply. We highlighted this last month - Daimler: Need to focus on Auto 2.0 (14 Jun 2017) . By recognising the scope of the necessary change, we believe Volvo's statement marks a large step in that direction. In the meantime, our only Overweight rated names are Autoliv and Michelin - both, in our view, well insulated from the structural and tech disruption risks.
European Environment Agency estimate of European premature deaths due to PM2.5 and NO2 - 432k and 75k people affected each year
Source: European Environment Agency, Morgan Stanley Research
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Authors
Morgan Stanley & Co. International plc
Harald C Hendrikse
+44 20 7425-6240 EMAIL
Morgan Stanley & Co. International plc
Victoria A Greer
+44 20 7425-7944 EMAIL
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