Global Auto Industry 2018: at A Crossroad: Primary Credit Analysts

Global Auto Industry 2018: At A
Crossroad
Primary Credit Analysts:
Vittoria Ferraris, Milan (39) 02-72111-207; vittoria.ferraris@spglobal.com
Alex P Herbert, London (44) 20-7176-3616; alex.herbert@spglobal.com
Nishit K Madlani, New York (1) 212-438-4070; nishit.madlani@spglobal.com
Eve Seiltgens, Frankfurt (49) 69-33-999-124; eve.seiltgens@spglobal.com
Margaux Pery, Paris +33 1 44 20 73 35; margaux.pery@spglobal.com
Chizuko Satsukawa, Tokyo (81) 3-4550-8694; chizuko.satsukawa@spglobal.com
Katsuyuki Nakai, Tokyo (81) 3-4550-8748; katsuyuki.nakai@spglobal.com
Machiko Amano, Tokyo (81) 3-4550-8659; machiko.amano@spglobal.com
Table Of Contents
Global Auto Sales Are Static, But Regions Are Heading Different Directions
Ratings Outlook For Global Automakers And Suppliers
How Disruptive Trends In The Global Auto Sector Could Affect Players'
Credit Quality
New EU-Japan Trade Agreements Will Have A Limited, But Positive

Impact
Rising Litigation, Regulatory, And Recall Risks Could Weigh On Ratings
New Trends' Pace Of Disruption To Vary Along With Ratings Impact
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Global Auto Industry 2018: At A Crossroad
The global automotive industry is at--or at least rapidly nearing--a major crossroad that could determine its long-term
trajectory. Unlike the past cycles of booms and busts, we're now seeing accelerating technological transformation and
changing consumer tastes and demands, which are likely to result ultimately in an industry that bears little
resemblance to what it was just a decade or two ago. Already on the world's roads are vehicles that directly consume
no petroleum-based fuel, vehicles that can navigate even busy city streets with no human intervention, vehicles that
aim more at serving not just a single owner but hundreds or thousands of ride-sharers.
Supporting those transformations are entirely new and disruptive companies, from automakers such as Tesla to
platform and software providers such as Uber to established technology giants looking to further transform the auto
industry into a high-tech showplace, such as Google, Apple, and Intel.
Overview
• Global automotive demand is likely to remain stable through 2017 and into 2018, roughly in line with our prior
expectations and varying by region.
• We expect ratings on automakers and suppliers to remain generally stable, with little upside, particularly in the
U.S. and Europe.
• Powertrain electrification is likely to be the most important disruptive mega-trend in the next decade, in our
view.
• Autonomous driving and new mobility services could over time challenge the business models of incumbent
manufacturers and suppliers.
• Partnerships between automakers and suppliers as well as alliances and restructurings will become more
common and vital to all companies' efforts to stay competitive.
What might all this mean for the credit quality of the current universe of automakers and auto parts suppliers for which
S&P Global Ratings maintains credit ratings? Specifically, how might electrification and autonomous driving affect
their credit profiles? With many forces converging on the global auto industry, S&P Global Ratings analysts worldwide
have combined here to look further into these disruptive trends, as well as set out our near term expectations.
Global Auto Sales Are Static, But Regions Are Heading Different Directions
What is our outlook for global auto sales for the rest of 2017 and into 2018?
We believe global automotive demand is likely to remain stable, largely in line our previous expectations. That is, we
see China's outlook remaining stable to positive, the U.S. showing some signs of softening, and European markets
(mostly) continuing on a moderate growth trend. Visibility remains low in markets such as Brazil, Russia, and India
because of likely volatility and macroeconomic uncertainty. We note that these markets account for less than 8% of
the global vehicle sales, while China alone represents one-third.

Chart 1
Table 1
Light Vehicle Sales
2018e 2019e
Units (in mil.) % change (year on year) Units (in mil.) % change (year on year)
U.S. 16.6-17.1 (2)-0 16.5-17.0 (0.5)-0.0
China 29.5-30.0 1.5-3.5 30.0-30.5 1.5-3.0
Europe 20.5-21.0 2.0-3.5 20.8-21.1 2.0-3.5
APAC (excluding China) 15.8-16.3 1.0-2.0 16.0-16.5 1.0-2.0
Global 95.0-97.0 2.0-3.0 97.0-100.0 1.0-2.0
e--Estimate. Source: S&P Global Ratings.
Global macroeconomic trends appear supportive of steady auto sales for the coming year or two. We expect global
GDP growth in 2017-2019 to accelerate to 3.6%-3.7% up from 3.1% in 2016. For 2018-2019, we expect year-on-year
real GDP growth in the 2.0-2.3% range in the U.S. and 1.9% in Europe. We expect steady growth in the U.S. and
economic improvements in the eurozone to support manufacturers' earnings. In the Asia-Pacific (APAC) region, we
see real GDP growth hovering at approximately 5.5%-5.6% in 2018-2019, driven by China and India, two key markets
for the auto industry. Meanwhile, the normalization of monetary policy in advanced economies has entered a new

phase, with the U.S. Federal Reserve aiming to shrink its balance sheet and the European Central Bank to taper asset
purchases. Rising borrowing costs might reduce margins for auto captive finance operations, which heavily rely on
capital markets, but we do not see it as a major risk for the auto market. We continue to see a risk that
trade-agreement revisions (namely the ongoing North American Free Trade Agreement renegotiation) or increased
tariffs (related to Brexit) will pose new hurdles for trade and global supply chains.
Chart 2
The U.S. auto market is slowing a bit, but SUVs and CUVs will keep leading the way
In the U.S., auto growth is clearly falling behind our earlier expectations in 2017, with a sales decline of 2%-3%.
Following a modest year-to-date drop, we expect sales to weaken slightly year over year in the fourth quarter of 2017,
despite the need for replacement vehicles following recent natural disasters in key markets such as Texas and Florida.
In 2018 and 2019, we think sales could weaken slightly from 2017 levels (relative to our prior expectations) but stay at
a relative healthy total of 16.5 million-17 million units based on our expectation for steady U.S. GDP growth, housing
starts, and gasoline prices. Other supportive factors include still-satisfactory data on vehicle affordability, an upturn in
homeownership among young adults, and single-family building permits being at a 10-year high. If these trends are
sustained in 2018 and 2019, it could support steady demand for autos in the U.S.
We expect automakers and suppliers in the U.S. to face margin pressure resulting from rising commodity costs, lower

sales volumes, or a shift in the product mix toward vehicles with lower profitability. Tighter credit availability, rising
interest rates, and less favorable lease options may also arise for consumers. We expect a significant number of light
truck launches in the next couple of years, which are likely to perform better than previous truck models because
automakers will likely focus more on better driver-assist technologies and infotainment features to improve their
competitive position.
In our base-case scenario for auto sales, we don't anticipate any material shift in the U.S. product mix away from
trucks. We believe most customers will prefer crossover utility vehicles (CUVs) to sedans due to their value
proposition (newer models with more space, better interiors, and improved fuel efficiency and ride handling). Any
significantly stronger sales of such vehicles and pickup trucks will help largely offset downside profitability risks due to
lower overall sales.
The key credit issue for automakers is to avoid being caught with oversupply at the top of the cycle and to maintain
discipline in slowing, but still hypercompetitive, markets. Automakers will need to continue to choose an optimal mix
of production cuts and discounting necessary to align supply, demand, and inventory levels.
Long-term economic trends (such as declining productivity growth, labor-participation trends, and trade dynamics)
suggest that the U.S. long-term potential GDP growth rate will dip below 2%, to just 1.8% over the next 10 years. Our
view also incorporates our belief that the current administration will fail to enact true tax reform and that any
infrastructure-spending package will be much smaller than the $1 trillion figure that was cited on the campaign trail.
Higher trade barriers (albeit a lower probability event relative to our earlier expectations) could increase vehicle costs
and trim sales volume and profit margins.
European auto sales are supported by economic growth, while Brexit and diesel remain concerns
Europe's auto market performance to date has been stronger than we previously expected, surpassing our projection of
sales growth in the 1%-2% range for 2017. Instead, light vehicles sales growth exceeded 4% in Europe in the first eight
months, thanks to improved performance in key Western Europe markets, mainly Germany, France, Italy, and Russia.
Overall sales are trending in excess of 20 million units for 2017, making 2017 the fourth consecutive year of growth.
Europe's strong performance is linked to improving economic conditions in the area. We expect 2017 GDP growth to
hit 2% up from 1.7% in 2016, as we project unemployment will continue to decline to below 8% in the next two years
from the double-digit peak reported during the recession. Other supporting factors include extremely accommodative
financing conditions, which we expect will characterize the whole of 2018. We believe the economic environment for
car sales will remain favorable in Europe, where we estimate GDP growth at 1.9% in 2018 and 2019. We thus expect
demand for cars to remain soundly in the 2%-3% range in the next two years.
Sales growth is reported in all European markets except for the U.K., as we anticipated. This is a result of the
uncertainties surrounding Brexit and lower real salaries mainly linked to a weaker British pound. We see the U.K. auto
market's prospects tied to ongoing negotiations with the EU. Any form of trade restriction would be detrimental for
cars produced in the U.K., which on average heavily depend on imported parts. In the worst case, such restrictions
could over time lead to British production relocating to the Continent.
Diesel car engines have become a key part of the engine mix in Western Europe, as they help meet stringent carbon

dioxide emissions targets in the EU of 95 grams per kilometer by 2021 on average for the sector, while providing a
better fuel economy. However, these engines emit high levels of harmful nitrogen oxide, and political and public
pressure to lower excessive air pollution levels is increasing.
In a sharp reversal of European auto sales trends up until recently, diesel-powered cars' share of new-vehicle sales
continues to drop. In Western Europe, diesel's market share fell to 42.7% in August 2017 from 48.3% the year before
according to LMC Automotive. In the main markets, the largest declines are reported in Spain, the U.K., and Germany.
We continue to expect diesel's market share to decline gradually, being replaced by gasoline and electric vehicles (EV).
We expect volumes and market share will continue dropping, and will make up less than 40% of the market by 2020
and about 30% by 2025, as bad publicity continues to weaken customer confidence.
Chart 3

Chart 4
Falling values for old diesel cars might weigh on consumers' willingness to buy new cars and could slow the
replacement cycle, thereby diminishing sales. This also adds to concerns about whether residual values will decline,
leading to losses at large auto manufacturers' captive finance operations that have material leasing businesses, in
particular in the premium segment where the share of diesel is highest.
For the three German auto manufacturers we rate, namely BMW, Daimler, and Volkswagen, captive finance assets
have been increasing and now total over €400 billion, up 51% since the end of 2013. The share of leased assets in the
portfolio for these three companies is about 30% on average, with BMW (31% at June 30, 2017) and Daimler (37%)
higher than VW (24%).

Chart 5

Chart 6
In addition, the replacement of diesel by petrol in consumers' preferences could potentially weigh on the capacity of
car manufacturers to hit their 2021 carbon dioxide emission targets in Europe.
Table 2
Top 20 Car Manufacturers' Average Carbon Dioxide Emissions
Average Co2 emission Average Co2 emission Change in average Ranking Ranking
for 2016 (g/km) for 2015 (g/km) emissions yoy (g/km) 2016 2015
Peugeot 101.9 103.5 (1.6) 1 1
Citroen 103.3 105.6 (2.3) 2 2
Toyota 104.0 107.6 (3.6) 3 4
Renault 105.6 105.9 (0.3) 4 3
Skoda 111.8 115.4 (3.6) 5 6
Nissan 115.0 114.1 0.9 6 5
SEAT 115.8 116.7 (0.9) 7 7
FIAT 116.0 117.6 (1.6) 8 9
Mini 116.4 117.0 (0.6) 9 8
Dacia 117.6 121.9 (4.3) 10 12
Volkswagen 117.7 117.8 (0.1) 11 10

Table 2
Top 20 Car Manufacturers' Average Carbon Dioxide Emissions (cont.)
Average Co2 emission Average Co2 emission Change in average Ranking Ranking
for 2016 (g/km) for 2015 (g/km) emissions yoy (g/km) 2016 2015
Ford 120.1 118.0 2.1 12 11
VOLVO 122.0 122.8 (0.8) 13 13
OPEL/VAUXHALL 122.4 126.3 (3.9) 14 14
BMW 123.2 128.0 (4.8) 15 19
KIA 124.5 127.7 (3.2) 16 18
AUDI 124.7 127.3 (2.6) 17 15
Hyundai 124.8 127.4 (2.6) 18 16
Mercedes 127.5 128.1 (0.6) 19 20
Mazda 127.7 127.5 0.2 20 17
Average 117.1 118.8 (1.7)
Source: Jato. Yoy--Year on year.
In Asia-Pacific, Japan shows steady growth, but China is slowing down

In Asia-Pacific (APAC), the overall market trend is broadly in line with our expectations, however we now see higher
risk in China's market than at the beginning of 2017.
The credit quality of Japan's automobile and auto components industries is likely to stay on a stable path for the next
year or two, in our view. New-car sales in Japan have been expanding over the last 10 months, resulting in 8.1%
growth through August 2017. Fueling this trend has been solid demand for small vehicles, which we believe results
from strategic new-model launches from key manufacturers. Thanks to the prospect of a steady economy and low
interest rates, we expect the recent steadiness in Japan's new-car sales to continue over the next one to two years.
The Association of Southeast Asian Nations' (ASEAN's) six major countries--Indonesia, Thailand, Malaysia, Philippine,
Vietnam, and Singapore--posted steady auto sales growth at 6% during the first eight months of 2017. Considering
stabilized commodity prices and a steady regional economy, we believe solid growth is likely to continue in ASEAN.
Conversely, we see a slowdown in China. New-car sales during the first eight months of 2017 were 17.5 million units.
While that's a 4.3% growth pace over the same period last year, it's notably lower than the 13.7% increase achieved in
full-year 2016 and 11.4% over the first eight months of last year. What potentially deserves more attention, though, is a
faster decline in average selling prices during 2017, according to some original equipment manufacturers (OEMs), and
the likely negative impact on profitability. Although we expect sustained auto volume growth in China over the next
two to three years at a pace close to or in line with GDP growth, ongoing competitive pressure due to industry
overcapacity and increasingly sophisticated consumer tastes will likely continue. In addition, various regulations, for
example the corporate average fuel consumption target, will likely force OEMs to increase capital spending.
Nevertheless, we do expect Chinese auto market leaders to keep registering robust growth in volume and profit.
Japanese companies have generally been outperformers on the Chinese market due to new-model launches in SUVs
and small cars, while South Korea's Hyundai is losing significant market share. Thus, each individual company's
strategic efforts are also important analytical factors.

Ratings Outlook For Global Automakers And Suppliers

Ratings on U.S. companies are stable, but not likely to rise much
The rating outlook for U.S. automotive companies is generally stable, with limited upside. We think ratings are
approaching a ceiling for most U.S. carmakers and supplier, with nearly 80% of those we rate carrying a stable outlook
(see chart 8). Furthermore, nearly 75% of U.S. rated issuers are at or above pre-recession rating levels. Following their
upgrade to the investment-grade category in 2013-2014, the country's two biggest carmakers, General Motors (GM)
and Ford, have both seen further upgrades to 'BBB'.
Chart 7

Chart 8
However, we see limited likelihood of the ratings for GM and Ford rising again over the next 12-24 months given
increasingly competitive conditions. EBITDA margins for both are likely to remain at about 8%-9.5%, at the higher end
of our average range of 6%-10% for global automakers over the next two years. We incorporate modest declines in
margins in our forecast for 2018 and 2019 to account for higher commodity prices (mainly steel), large engineering
expenses for autonomous and electrification-related technologies, increased regulatory costs, and pricing pressure in
several key markets. Those will be partly offset by cost efficiencies.
We assume increasing shareholder returns, though both automakers remain committed to maintaining very strong
automotive cash balances to weather the next cyclical downturn. We also expect increased pressure on GM's and
Ford's captive finance units from lower auction values. That indicates increased supply, lower values, and increasing
residual risks across vehicle segments. This is based on our expectation that nearly 12 million off-lease vehicles will be
returned to dealers through the end of 2019.
We also assume that industry pricing pressure will intensify over the next 12-18 months, which could hurt new-vehicle
margins given the correlation between new-car and used-car prices after several years of competitive pricing. Pressure
is likely to persist on used-car values especially in small cars and trucks.

For U.S. auto parts suppliers, we believe credit quality has approached a peak, with signs of a modest deterioration in
credit metrics for some, consistent with the normal cyclicality inherent in the automotive business. We expect steady
low-single-digit revenue growth in 2018 as new business wins and higher-value content are offset by foreign currency
headwinds and higher commodity prices. We expect EBITDA margins for most U.S. suppliers to flatten out as they
focus on improving their manufacturing and engineering footprint and cut operational costs.
We expect credit metrics to stay steady for most U.S. suppliers. While some Tier 1 companies continue to absorb large
acquisitions and manage stand-alone operations after spin-offs, we don't think their appetite has been diminished for
tuck-in purchases, especially of firms that help fill gaps in their technology portfolios. Moreover, for suppliers such as
Lear, BorgWarner, and Delphi Plc, we expect sustained streamlining of cost structures as they look to hold on to
investment-grade ratings by following disciplined financial policies that support low debt leverage.
A key credit factor since the last downturn is the higher flexibility of labor costs (more production in Mexico with less
restrictive union contracts). This has given our rated suppliers an improved median cost structure, with about
75%-80% variable costs, compared with roughly 50%-55% prior to the Great Recession.
Ratings on European companies are stable, but also have little upside
The rating environment for European car manufacturers should remain generally stable over the next two years. We
believe that despite supportive market fundamentals, rating upside will be limited, due to continued high research and
development (R&D) and capital expenditure (capex) spending to invest in new models and meeting heightening
environmental standards. Meeting these standards could be even tougher if the decline of diesel's market share
accelerates to the benefit of petrol.
That said, the majority of car manufacturers enjoy some headroom to absorb downside risks as many feature zero or
low S&P Global Ratings' adjusted debt levels (excluding captive finance operations), and aim to cover capex costs with
operating cash flows.
Our main concern is whether automakers' will be able to defend the profitability of their industrial operations while
investing in electrification, and digitalization--costs that can't be postponed in light of mounting competitive pressure
and stricter environmental regulations. However, their impact on ratings should be viewed on a case-by-case basis
because the bulk of OEMs have strengthened efforts to reduce other costs.
At the same time, we expect European car suppliers will reap benefits from ongoing cost reductions and commitment
to higher efficiency. We see strong order books in response to the acceleration of electrification and, in some cases, by
the sharing of development costs with OEMs. In the longer term however, competition in a full electric mobility
environment will increase for auto suppliers.
Stable outlook on Japanese companies could depend on trends in the key North American market
In APAC, the credit quality of Japan's automobile and auto components industries is likely to stay on a stable path for
the next year or two, supported by steady revenue sources and companies' sound financial health, in our view. We
believe major Japanese automakers and auto suppliers will generate slightly weaker business results year over year in
fiscal 2017 (ending March 31, 2018). We expect a slowdown of new-car sales in the key North America market, which
has supported growth of these companies' revenues in recent years. Additionally, higher sales incentives in North

America will weigh on profitability. We also see intensifying competition in emerging markets and rising raw material
prices.
Nevertheless, we believe these companies are likely to maintain generally stable profitability underpinned by
geographically diversified business portfolios. For example, a slowdown in U.S. sales would be partly offset by
favorable sales in Japan. Also contributing to steady profit margins is technological competitiveness in EVs and other
type of environmentally friendly cars to meet tighter environmental regulations, as well as autonomous driving
technologies. In addition, ongoing efforts to reduce costs have been major mitigating factors against foreign exchange
rate fluctuations.
How Disruptive Trends In The Global Auto Sector Could Affect Players' Credit
Quality
We recognize the potential for electrification, autonomous vehicles, and new mobility services such as ride sharing to
shake up the auto industry landscape, even with the many questions involving risks relating to regulations, safety,
technology, and insurance. We believe these issues will have a mixed impact on the credit quality of both carmakers
and auto suppliers.
For automakers, the risks related to margin pressure from increased investments without a clear line of sight into
profitability outweigh the long-term opportunities. That's especially the case given high capex and R&D requirements
that will limit financial flexibility prior to the next downturn. In the longer term (beyond five years), these trends could
benefit the credit quality of automakers that can secure a first-mover competitive advantage and leverage their scale to
achieve high returns on invested capital.
Electrification's impact on automakers and suppliers

The pace of powertrain electrification is likely to be the single most important mega-trend in the next decade, but the
penetration could occur at different stages in various markets.
In China, electrified new vehicles could expand to represent 35% of new car sales in 2026 under the stimulus provided
by the new carbon scheme to be introduced in 2019. We estimate that in Europe electric vehicles, that is battery
electric vehicles (BEV) and plug-in hybrids (PHEV), will account for about 25% of light vehicle sales by 2025. This is in
line with some of the forecasts by major manufacturers such as VW. In the U.S., we believe though that electric cars
will represent some 10% of new vehicle sales by 2025.
EVs are expensive to produce currently, due to high battery costs, but advances will lead to a more cost-competitive
proposition for both carmakers and customers. The success of automakers such as Tesla, GM, and Nissan (current U.S.
market leaders in fully electric vehicles) in eventually producing a profitable, high-volume EVs could significantly
accelerate the pace of investments from most global automakers as they look to stay competitive.
Given our expectations for ongoing improvements in battery technology, the two most important factors that could
fuel higher consumer demand for EVs, relative to our expectations, will be the extent of government subsidies and
reductions in battery costs. Nevertheless, the key challenge for OEMs is how deftly they can share the responsibility of
developing new technologies with their suppliers without relinquishing the core value of the vehicle in consumers'

eyes.
While some OEMs may still opt to manufacture electrification equipment themselves, we expect suppliers to start
playing a much bigger role. For suppliers, new electrified powertrains represent a business opportunity. A key focus
will be on suppliers that innovate and produce value-added components to assist carmakers in meeting new carbon
dioxide emission and fuel economy standards, for example, with products such as turbochargers or direct fuel
injection, both of which improve internal combustion engine (ICE) efficiency. Components such as turbochargers and
power electronics solutions will experience increased demand as vehicle electrification accelerates. Other suppliers
that could benefit include those that manufacture and design products that provide the critical electrical and
electronics backbone that supports increased vehicle electrification, reduced emissions, and higher fuel economy
through weight savings.
Electrification technologies, such as advanced propulsion systems and drivelines, could therefore result in more
content per vehicle for suppliers, at least until fully electric vehicles become mainstream, and there could be increased
outsourcing of standard auto components, such metal components and assemblies, because automakers have to focus
capital investments in autonomous vehicle and electrification technologies. Seating suppliers could also benefit from
increased penetration due to demand for lighter-weight seats to improve battery range.
Overall, trends toward electrification could have a neutral to slightly positive impact on suppliers' credit quality over
the next three to five years as higher engineering and R&D-related investments mostly offset increased revenue.
However, beyond 2030, when electrification technologies catch up to meet the power, load, and duty requirements of
larger vehicles, and fully electric vehicles become more mainstream, it will create significant downside to suppliers'
business risk profile because the majority of the traditional auto supplier segments linked to the ICE powertrain will
become obsolete. In the longer term, possibly beyond 2035, these trends will likely create an extremely narrow set of
mega-suppliers with enhanced diversity, scale, and profitability.
Autonomous driving's impact on automakers and suppliers

We see investments in autonomous driving as more of a risk for the sector as a whole, given the significant
deployment of companies' resources toward similar technologies. Ultimately, a narrow set of factors will determine
what technologies make it to market, determined mainly by insurers, regulators, and consumers. This is unfamiliar
territory for many automakers and suppliers, and they are competing with large, cash-rich, powerful
technology-focused companies such as Google and Apple, and large electronics makers such as Samsung, alongside
auto-industry disruptors such as Tesla. In our view, through ongoing collaborative partnerships, automakers and
suppliers will work increasingly together to share long-term investments with incremental design- and
engineering-related synergies.
If a carmaker's autonomous vehicles are more likely to be ready for large-scale commercial deployment without
human drivers much sooner than widely expected, it could lead to an improved business risk profile assessment
because it would create a sustainable competitive advantage. The rapid deployment of self-driving fleets could help
first movers establish significant barriers to entry, particularly in major metropolitan areas, where penetration of
autonomous ride sharing over vehicle ownership is likely to be higher. However, a risk factor is that autonomous
driving in cities will reduce the importance of branding and lead to a more commoditized experience for passengers

who are no longer drivers.
We also see above-average growth opportunities for active safety and automated driver-assistance systems. These
features include adaptive cruise control, autonomous parking assistance, blind-spot detection and surround view,
collision warning and avoidance, and lane-departure warning, as well as signal and power distribution, centralized
computing platforms, and data services. Sensors will be needed in engines, drivetrains, and tires, as well as driver
information systems, which will become more crucial. Seating suppliers could also benefit from seats that can integrate
and optimize electronic content that increases safety and provides occupant infotainment and connectivity. We also
expect auto suppliers will generally transform from electrification component suppliers into system suppliers.
International cooperation between OEMS and suppliers is becoming more common. In one instance, a new company
called HERE, which provides mapping data and related services, is owned by a consortium of German automotive
companies, including Audi, BMW, and Mercedes. Other examples are the cooperation between leading car companies
Audi, Daimler, Tesla, Toyota and Volvo with auto suppliers like Bosch, ZF Friedrichshafen, Autoliv, and Nvidia to
develop artificial intelligence technology for the European New Car Assessment Program (NCAP) safety certification
for the mass deployment of self-driving vehicles. We expect this trend to continue over the next years.
Recent actions by large suppliers are noteworthy. Delphi's announced spin-off of its powertrain business underscores
the need to focus its resources on advancing active safety, connectivity, and electrification amid increasing
competition from large industry players and cash-flush Silicon Valley firms. Autoliv's recently announced strategic
review to consider spinning off its electronics business is another signal that indicates the importance of agile
innovation as global suppliers compete for tens of billions of dollars in orders from automakers on the cusp of a
massive transition to electric and self-driving vehicles.
In our view, auto suppliers will need to be more proactive in offering new products to OEMs instead of waiting to get a
new order, which is why we expect to see more partnerships emerge in developing new products. A recent example is
the strategic partnership for development of cutting-edge interior and safety technologies for autonomous vehicles
between ZF Friedrichshafen and France-based Faurecia, both leading global systems suppliers for cars and trucks.
Another example is the agreement between German auto-supplier Continental and Chinese carmaking start-up Nio to
work together in the fields of EVs and autonomous vehicles.
New EU-Japan Trade Agreements Will Have A Limited, But Positive Impact
We consider trade agreements aimed at eliminating tariffs as positive for the auto sector, and we note that Japan and
EU leaders reached a political consensus on two landmark trade agreements, the Strategic Partnership Agreement
(SPA) and the Economic Partnership Agreement (EPA) in July 2017. The EPA agreement includes a seven-year tariff
phase-out for all automobiles and immediate tariff elimination for auto components. Europe is a net importer of autos
produced in Japan.
The EPA's impact on the European automobile industry is difficult to assess and contingent upon exchange rates, but
we believe it will be rather limited. The progressive abatement of trade limits and restrictions would be gradual,
spanning seven years. Based on the most recent statistics, EU autos exported to Japan represent less than 1% of EU

GDP. An independent London School of Economics impact assessment of the EPA trade deal with Japan suggests it
could increase EU output by up to 0.76%. Assuming all else remains equal, exchange rates in particular, the impact on
EU autos exports would not significantly exceed 1% and would not in our view have a material impact on our ratings.
We don't believe the EPA would affect the credit quality of Japanese automakers, at least over the next two years or
so. This is primarily because it would take seven years for tariffs to phase out for all automobile exports from Japan to
the EU, and secondly because the EU represents less than 10% of vehicles sold by Japanese automakers globally.
Japan is currently looking for export opportunities as local sales remain in the long-term shrinking trend. Domestic
passenger car sales fell 13% to 4.1 million units in 2016, from 4.7 million in 2015, and so did local vehicle production,
to 7.8 million from 9.0 million in 2005. The EPA's elimination of a 10% EU tariff on Japanese automobiles may help
OEMs somewhat increase exports with more competitive prices and retain as much production as possible at home.
Even looking out over the next 10 to 20 years, however, we are skeptical about Japanese OEMs reaping material
benefit from the deal because of the following factors:
• Their small presence in Europe isn't likely to improve materially because of their relatively weak brands in Europe.
• They're increasing production in the EU, now at about 1.66 million per year, which accounted for over 70% of
vehicles sold by Japanese automakers in the EU.
• Adverse impacts of Brexit could outweigh any benefit from the EPA for Nissan, Toyota, and Honda because they
have assembly plants with sizable production capacity in the U.K.
• During the seven-year transition period, EVs may become widely accepted because virtually all major global OEMs
are accelerating their focus to electrics, a powertrain technology for mass market in which Toyota and Honda lag
behind European peers.
In our view, Japanese auto suppliers are more likely to gain immediate benefit from the EU-Japan deal than OEMs
because many suppliers continue to export core, high-value-added auto components and systems from Japan in order
to minimize excess production capacity overseas. We also believe automakers with a high proportion of sales in the
EU and their main suppliers could receive a meaningful boost. For example, Mazda should benefit more than many
peers because its unit sales in the EU accounted for about 15% of its total sales in 2016.
Rising Litigation, Regulatory, And Recall Risks Could Weigh On Ratings

Mostly due to VW's dieselgate emissions scandal, legal and regulatory risks are rising. VW has set aside €22.6 billion
to cover charges mainly for illegal behavior in the U.S., namely installing computer software (called "defeat devices")
that enabled cars to pass laboratory emissions tests, even though they emitted far higher levels of carbon dioxide and
nitrous oxide under real driving conditions. VW announced recently that it would take a further provision of €2.5
billion in its third-quarter results as a result of higher costs associated with the repurchase of diesel cars in North
America. Legal risks can also arise from class and investor actions, which are even more unpredictable. For example,
VW faces investor lawsuits of about €9 billion (as of Dec. 31, 2016), against which VW has booked contingent liabilities
of just €3.1 billion, which indicates that these claims may lead to additional payments by VW in the future.
While no other auto company has been hit with such severe penalties, various other manufacturers have been placed

under numerous and wide-ranging investigations and litigations relating to diesel engine emissions. In Europe, Daimler
AG and Fiat Chrysler Automobiles face legal action in the U.S., but no provisions have been made. Also in Europe,
German carmakers could also face cartel fines if the European Commission confirms suspicions of collusion. Swedish
truck manufacturer Scania was recently fined some €880 million for collusive practices in Europe over the last 14
years. The company disputes the accusations and will appeal.
In many cases, the timing and extent of potential costs is unknown, so generally we do not factor them into our
forecasts until they arise. However, we may use estimates in a scenario analysis to help judge financial flexibility within
a rating on a forward-looking basis.
Aside from the risk of charges, we expect legal, compliance, warranty, and recall costs to continue to rise, pressuring
for automakers' margins.
Carmakers also face negative reputational and brand consequences that may hurt sales or increase the need to offer
larger discounts and other incentives. Furthermore, in major cases, we may conclude that such events demonstrate
weaknesses in management and governance, for example, poor internal controls or risk management, which may be
negative for the ratings.
New Trends' Pace Of Disruption To Vary Along With Ratings Impact

While it's very clear that the transformation of the auto industry is under way, it's too early to tell how the auto
landscape will ultimately be reshuffled. That said, we believe each of these trends will reshape players' competitiveness
at a different pace, with electrification being the forerunner and likely to have the greatest impact on the credit quality
of the companies we rate in the next three years.
The electrification trend is being accelerated by increasing environmental concerns, tightening emission regulations,
and rising litigation risks, at least in Europe in light of dieselgate. Electrification of powertrains also accounts, in our
view, for the bulk of extra costs the industry is taking on in its 2018-2020 planning. It could therefore have a significant
impact on the profitability of both car manufacturers and suppliers over the next years. Manufacturers able to quickly
spread electrification options to their entire fleet will probably enjoy market appeal, but at a relatively high cost, which
could weigh on margins. We expect cost competitiveness to be the leading differentiating factor in our relative
assessment of the credit quality of our issuers in the next three years.
Autonomous driving is likely to be less disruptive for the industry at this stage, in our view, as it is not only about
supply-driven innovation, but depends on regulatory developments. At such, it could impact large markets like the U.S.
and China first while being delayed in Europe, where reaching a consensus among different governments could prove
more challenging. Given that investment in autonomous driving don't currently enjoy high visibility on commercial
returns, players might see them as less of a priority at this stage.
We expect the industry's transformation over the next two to three years will be supported by a relative favorable
macroeconomic conditions and steady demand, despite lower growth in China and soft performance of the U.S.
market. Geopolitical risks persist, and we see them as mainly linked to decisions on trade agreement (i.e., NAFTA and

Brexit negotiations) that could in a worst-case scenario result in additional costs for the industry. However, the
abovementioned risks can be hardly reflected in our current forecasts for individual companies. In this environment,
we believe that ratings upside in the industry will be limited, but that players' credit quality will largely remain stable.
Related Research
• S&P Global Ratings Expects U.S. Auto Sales To Decline Modestly To 16.8 Million-16.9 Million Units In 2018 And
2019, Oct. 5, 2017
• Japan Corporate Credit Spotlight: Automobiles And Components, Oct. 4, 2017
• No Smooth Ride For German Carmakers After Federal Election, Sept. 25, 2017
• Credit FAQ: Could Allegations Of Collusion And Declining Diesel Sales Stall European Automakers?, Aug. 7, 2017
• S&P Global Ratings Lowers U.S. Auto Sales Forecast To 17.2 Million In 2017 And 2018 As Demand Headwinds
Persist, July 7, 2017
Only a rating committee may determine a rating action and this report does not constitute a rating action.
Additional Contact:
Industrial Ratings Europe; Corporate_Admin_London@spglobal.com

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Global Auto Industry 2018: at A Crossroad: Primary Credit Analysts

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Global Auto Industry 2018: At A

Ratings Outlook For Global Automakers And Suppliers

New EU-Japan Trade Agreements Will Have A Limited, But Positive

Rising Litigation, Regulatory, And Recall Risks Could Weigh On Ratings

New Trends' Pace Of Disruption To Vary Along With Ratings Impact

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e--Estimate. Source: S&P Global Ratings.

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Source: Jato. Yoy--Year on year.

In Asia-Pacific, Japan shows steady growth, but China is slowing down

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Ratings Outlook For Global Automakers And Suppliers

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Electrification's impact on automakers and suppliers

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Autonomous driving's impact on automakers and suppliers

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who are no longer drivers.

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Rising Litigation, Regulatory, And Recall Risks Could Weigh On Ratings

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New Trends' Pace Of Disruption To Vary Along With Ratings Impact

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