www.td.com/economics TD Economics Special Report February 6, 2008 AUTOMAKERS BRACE FOR A DIFFICULT YEAR Over the past year, the challenges facing the Canadian auto sector have intensified. The outlook for U.S. sales HIGHLIGHTS has deteriorated markedly as the risks of U.S. recession • U.S. sales to tumble by 5% this year; Canada’s have increased. But, while the U.S. sales picture should impressive sales’ winning streak to come to an begin to turn the corner in 2009 – setting the stage for a end modest bounce back in North American output – other • The weaker demand environment to set the structural impediments threaten to weigh on the Canadian stage for an 8% drop in Canadian assemblies auto and parts sector over the medium term. Most impor- in 2008 tantly, Canada’s eroding cost position has come onto cen- • Next year, the start-up in operations at Toyota’s tre stage in light of the surging Canadian dollar, moves by Woodstock plant should underpin a moderate the Big Three in the U.S. industry to lower costs and rising recovery in production competition from China. This negative swing in relative • Real output in the Canadian parts sector to fol- cost position has raised concerns about Canada’s ability to low suit, with significant cuts this year to be secure investment. Increasing environmental measures followed by a partial bounce-back in 2009 by governments also present a major longer-term challenge • New environmental regulations and the recent for the sector as a whole. drop in relative competitiveness vis-à-vis the U.S. present key medium-term challenges for the sector AUTOMOTIVE SALES AND PRODUCTION U.S. sales to tumble by 5% in 2008 Per cent Change Sales in the United States, which account for 85% of North American sales, have been trending downward for 2006 2007E 2008F 2009F the past 3 years. In 2007, total sales of cars and light sales SALES OF LIGHT VEHICLES were dampened in part by elevated gas prices and a re- NORTH AMERICA -2.1 -2.2 -4.4 3.4 duction in manufacturer incentives. And the near-term out- Canada 1.8 2.4 -0.9 1.2 look is even bleaker, with U.S. sales expected to tumble United States -2.6 -2.5 -5.2 3.6 Mexico 0.6 -3.5 2.0 4.0 by 5% in 2008, to a ten-year low. Consumer fundamen- tals have continued to deteriorate in recent months, as the PRODUCTION OF LIGHT VEHICLES U.S. subprime housing woes broaden from the real estate NORTH AMERICA -3.2 -1.6 -3.5 3.8 market to the economy as a whole. Employment growth Canada -4.8 1.8 -7.6 5.9 is likely to limp along at a mere 0.5% in 2008, compared to United States -6.3 -3.1 -3.6 2.8 its trend rate of roughly 1.6% over the past few years. Mexico 21.8 2.1 2.7 6.1 We expect the U.S. to avert a full-fledged recession, but Forecast by TD Economics as at January 2008 only by the narrowest of margins. Still, with consumer Source: DesRosiers Automotive Reports, Ward's, TD Economics confidence eroding, lending standards being tightened and Automakers Brace for a Difficult Year1 February 6, 2008 www.td.com/economics little price relief in sight at the pumps, demand for motor vehicles will be hit harder than most other consumer goods. NORTH AMERICAN LIGHT VEHICLE SALES While we expect the U.S. economy to improve somewhat Units (000's) 22,000 in 2009, the recovery in auto sales will be relatively modest Forecast and only partially recoup the loss suffered this year. 20,000 Canadian auto sales’ winning streak to end 18,000 Canada’s gain in sales in 2007 – to the second highest level on record – was among the big surprises of the year, 16,000 since sales were already at elevated levels in 2006. Sales growth was strong across the country, with the sole ex- 14,000 ception of Ontario, which posted a 2.7% decline. New- foundland & Labrador and Saskatchewan outpaced the 12,000 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 other provinces, with stellar gains of 16% and 13% re- Source: WardsAuto.com; spectively. But after a 5-year run of robust sales – with Forecast by TD Economics as at Jan. 2008 more vehicles sold than any other 5-year period on record – Canadian sales will likely fall from their peak. Looking to twice their year earlier levels. And although the major- ahead, even though Canada’s economy and job market don’t ity of these vehicles were used, most were only a year or face the same downside risks as those in the United States, two old. As such, dealers in Canada have since moved to we expect a significant slowdown in job growth from coast close some of the price gap in order to keep residents shop- to coast in 2008 and into 2009. ping at home. At first, these dealers were reluctant to slash In addition to weaker job growth and a lack of pent-up sticker prices to match those across the border. Instead, demand, Canadian motor vehicle sales will likely come un- they introduced cash incentives as well as attractive lease der some further pressure from cross-border competition, and financing rates in order to closer match their prices which is accounting for a relatively small but growing share with those of their American counterparts. Even the for- of total Canadian vehicles sales. The pressure intensified eign-based automakers, which rarely offer incentives and in the autumn when the Canadian dollar rose to parity. low interest rates, provided substantial discounts for Ca- While the consumer price index (CPI) shows that the price nadian-bought vehicles. But recently, some Canadian deal- of new vehicles in Canada fell in 2007, some analysts esti- ers have announced that they will cut retail prices and bring mated as recently as November that automobiles in the them closer in line with U.S. prices. Nonetheless, the el- U.S. were $5,000 cheaper on average. By November, the evated loonie could keep U.S. imports at above-average number of vehicles brought across the border had surged levels over the forecast period. Overall, we expect Cana- dian light vehicle sales to decline by about 1% this year, AUTO SALES BY PROVINCE, 2007* before edging up by a similar magnitude in 2009. % change Y/Y Newfoundland Mexico to outperform in 2008 Saskatchewan A surge in cross-border shopping from the U.S. also P.E.I. weighed on new vehicle sales in Mexico, which, after 3 New Brunswick years of growth, fell by an estimated 3.5% in 2007. In Alberta addition to the influx of U.S. imports, the decline in sales B.C. was magnified by weakening consumer confidence, and a Manitoba slackening in the rate of job growth. Among the three Quebec Nova Scotia NAFTA countries, only Mexico is headed for a sales gain Ontario this year. The Mexican government has budgeted for heavy investment in highway construction and repairs in -5 0 5 10 15 20 2008, which could encourage consumers to step-up their *To November 2007; Source: Haver Analytics new vehicle purchases. Nonetheless, the projected gains of 2-3% over the next couple of years pale in comparison Automakers Brace for a Difficult Year2 February 6, 2008 www.td.com/economics NORTH AMERICAN AUTO SALES BY COUNTRY tions through 2008, and to reduce its global cost base to 23% of revenue by 2012. Ford revealed an accelerated Units (thousands) Units (thousands) 3,000 20,000 plan in 2006, in which the workforce would be scaled back Forecast and 14 plants in North America will be idled and cease production through 2012. These cost cuts were intended U.S. (RHS) to restore the company to profitability by 2009. 2,000 15,000 With these plans well underway, it is clear that progress Canada (LHS) by the Big Three has been made. Rather than integrating with its German counterpart, Chrysler split from Daimler 1,000 10,000 last year, and is now owned by a private equity firm, Mexico (LHS) Cerberus Management LLC. While Chrysler no longer reports financial results, the company is said to be meet- 0 5,000 ing, if not exceeding its financial targets. The Big Three 1990 1993 1996 1999 2002 2005 2008 together cut production by an estimated 5% and shed nearly Source: WardsAuto.com; Forecast by TD Economics as at Jan. 2008 100,000 jobs in North America in 2007, with further cut- backs announced for 2008. GM and Ford shut down a to the ten-year average of 12%, further signaling matura- total of 7 facilities in 2007 and both companies appear to tion of the market. be on track to achieve their multi-year profit objectives. Overall, North American sales are likely to drop by more than 4% in 2008, which would mark the worst continental Big Three market share fell further in 2007 performance since the mid-1990s. In 2009, continent-wide With the Big Three focused on implementing their re- sales should improve, but remain at a relatively depressed structuring plans and reducing incentives to restore profit- level. ability, sales volumes remained under pressure last year. Another challenge for the U.S.-based automakers contin- A bumpy road ahead for producers ued to be product mix. The Big Three have traditionally For Canada’s auto and parts producers, the weakening been superior in the North American light truck market.