The Suddenly Rising Cost of Making a Car
A jump in automotive commodity prices adds to car makers’ worries in 2017
By Stephen Wilmot
Photo: Tony Ding/Associated Press
The voguish theme of “reflation” has driven a rally in car stocks over the past three months.
But reflation has a dark side, too: rising raw-material prices. The Trump jump in share prices could be an exit opportunity for investors before the squeeze on profits becomes more apparent.
The extra costs necessary to research, design and equip cars with new gizmos, including electric powertrains, self-driving features and connections to the digital cloud have understandably garnered attention in recent months. A step-up in investments in autonomous technology was the key reason why General Motors missed analysts’ forecasts for fourth-quarter profit last week.
But a more traditional form of inflation will also weigh on car makers’ margins this year: higher input costs. An index of automotive commodity prices like steel and rubber compiled by UBS is currently 38% above its level a year ago. European car makers, for instance, will face between €200 million ($212.63 million) and €700 million in extra costs each, depending on their unit sales, notes Horst Schneider of HSBC.
GM and Mercedes-maker Daimler have both played down the scale of this problem in recent calls with analysts. GM said raw-material costs as they currently stand could trim its profit, all else being equal, by a figure in the “low hundreds of millions of dollars” this year, while Daimler’s comments hinted at an impact of roughly €200 million—just 1.4% of 2016 adjusted operating profit. Both companies gave outlook statements implying ongoing earnings growth, albeit at a modest rate.
The problem is that such projections look more dependent than in previous years on ongoing growth in vehicle sales. Input costs also rose rapidly in 2010 and 2011, following the financial crisis, but this coincided with a recovery in consumer demand in key markets such as the U.S., China and the U.K. Cutting costs and using up spare capacity in factories more than offset the burden of rising costs on margins. But now both U.S. sales and most car makers’ operating margins are at record highs.
If demand remains buoyant in key car markets—and stock prices imply a surge in optimism about prospects in the U.S.—then manufacturers should eke out further profit growth. If it doesn’t, however, profits would crater in a perfect storm of falling sales and ballooning product-development and unit-input costs. Heads investors win a bit; tails and they stand to lose a lot. On balance, this looks a good time to be selling car stocks.