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Tuesday, 24 October 2017

Accelerate to accumulate

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The performance of Germany’s car giants in the bond markets is a reflection of what is happening in the real economy as they swerve past Europe’s slowdown and map out the route to success in China.

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The word Zeitgeist is going global, and it is travelling in a German car – for when it comes to corporate issuance, the spirit of the era is definitely Teutonic and the auto giants are setting the pace.

A high-octane performance by carmakers Volkswagen, BMW and Daimler reflects the wider activity of German corporates in the debt markets as issuers capitalise on continuing demand to diversify funding.

“Demand for corporate credit out of Germany has remained very strong and the renewed uncertainty around Europe – Cyprus, Italy – if anything, has helped to underscore the strong case for German corporate credit among investors,” said Lars Moeller, a director in the corporate DCM team at Credit Suisse.

But behind multiple issues by the carmakers is an unrivalled industrial performance as they pull away from competitors mired in a European slump and conquer overseas markets. No better sign of the confidence this is giving them came in January when Volkswagen signalled its ambition by embarking on a €50bn plan to oust Toyota as the world’s top automaker.

Germany’s enthusiastic participation in European corporate debt markets reflects how investors are mesmerised by the strong performance of the country’s real economy.

Marcus Schulte, head of FIG DCM in Europe at Credit Suisse, said demand for German product was as strong as ever but as banks have reduced their issuance, SSAs and corporates have emerged as the key drivers of growth in the primary market.

“The appetite externally and internally for German credit has been as good as ever. Scarcer bank paper is easily absorbed, you have strong appetite for German corporates and, by its safe haven nature, appetite for German sovereign paper remains structurally strong.”

Martin Wagenknecht, head of DCM for corporates, Germany, for Societe Generale, said that if some of the exuberance in the market overall had faded after 2012, the performance of the German automakers has nonetheless been exceptional: “2012 was a tremendous year in terms of volume. The numbers for 2012 indicate that the automakers are a steady and good source of bond issuance overall. Daimler did something like €15bn in bond issues, Volkswagen €19bn, and BMW €8.5bn and these are tremendous amounts even if you compare that to how much overall has been issued in the market.”

Fuelling debt strategies

Success in the debt markets has been accompanied by innovation as the carmakers diversify on the traditional mix of senior financing, ABS, and customer and saver deposits.

If companies are still predominately selling euro or Eurodollar debt, greater liquidity has made other investors and currencies more accessible. There is growing enthusiasm for paper in Australian, New Zealand and Canadian dollars, Swiss francs, Mexican peso, Chinese renminbi and even Indian rupee. Another departure was a mandatory convertible by Volkswagen last year although most observers see this as a one-off.

So what is fuelling these debt strategies? First, the big three automakers are all cash-generative so need relatively little funding as manufacturers. Volkswagen’s investment plans and M&A activity aside, much of their funding is destined for the ongoing refinancing of debt in support of finance arms that service leasing contracts and lend to other corporates in order to sell the product. As the key differences between cars today boil down to brand cachet and financing, stronger balance sheets allow the Germans to offer consumers better terms – a crucial factor in buying a car.

As car financing drives funding needs, the volumes seen in 2012 reflected sales results – a link that means if sales remain strong the sector will continue to be a tremendous source of issuance because of a huge portfolio of debt outstanding that has to be refinanced.

Marcus Schroeder, global head of automotive corporate finance for Societe Generale, said: “It is partly a question of size. If you look at a company like Volkswagen, they have a financial services business with a huge balance sheet and the average tenure for the financing is about three years. VW has roughly €120bn financial services debt outstanding with an average maturity of three years. In terms of volume, this creates a huge supply. You have to refinance and roll over year by year, and this is linked to issuance.”

The German premiums generate huge cashflow – allowing them to sit on hoards of €10bn–€20bn, giving them huge financial power and stronger ratings. Put this alongside additional capital and R&D expenditures, and market forces are sorting out the sheep from the lambs.

The Germans’ sales performance contradicts that of rival carmakers across Europe, where the auto industry is in crisis. In 2012 sales slumped 8.2% to a 17-year low and this year is shaping up to be as bad: European car sales shrank again in March, with forecaster LMC Automotive predicting a baseline fall of 3% to 12.7m vehicles.

The big divide

While Germany has not been immune to the slump – car sales fell 13% in the first quarter – its plants are buzzing and the number of vehicles coming off production lines this year is expected to be 5.4m, 500,000 more than in 2000.

Christoph Seibel, head of corporate DCM Europe at RBC Capital Markets, said: “If you look at Europe, clearly there is a pretty big divide between the German car companies and the others. The Germans are all Single A rated, while the others are all non-investment grade or thereabouts, so it is actually quite difficult to compare them in terms of like for like – they are in a completely different yield game and look at markets in a completely different manner.”

Structural factors vie with good fortune to help explain this virtuous position. First, the German carmakers benefit from favourable political and macroeconomic conditions – the debt crisis and the existence of the euro – that have opened ground between them and rivals. Recession has hurt PSA Peugeot Citroen and Fiat, which rely heavily on the European market. Last year VW pushed up market share in Europe 1.6 percentage points to 24.8%.

If the trend to issue paper in other currencies suggests a loosening of ties with Europe, the German carmakers still derive significant earnings from their domestic market and base their production strengths on advantages at home – in particular the benefits of labour market reforms introduced in the early 2000s and years of technology gains. BMW’s largest plant at Dingolfing, for example, is the country’s most efficient, and economies of scale are a huge component of success for VW, whose modular frames and platform-sharing will slash costs.

Wooing China

Clever marketing has also created unbeatable brand perceptions, a good example of which can be found in the way the Germans have embraced social media and digital technology to woo Chinese consumers.

SG’s Schroeder said: “Germany is still an engineering-driven country: at the end of the day it is all about innovation, engineering skills and quality – Germans are leading in terms of new patents and innovations. Quality is the leading factor here, and the marketing skills and the ability to sell cars at a higher price.”

Finally, the automakers exude sheer ambition, with VW typifying an attitude towards competition that combines a high-quality product with aggressive pricing. It is not only producing cars, but also trucks through MAN and Scania – offering huge room for growth in India and China.

If the cautious European outlook – industry insiders do not expect a turnaround until the third quarter – is suppressing hopes for 2013, sales in the world’s largest markets are growing. Standard & Poor’s projects US sales will reach their highest level since before the crisis. VW reported a 3.1% increase in its March US sales with Audi up 14%, sales of Daimler’s Mercedes-Benz rose 6.5% and those of BMW rose 13%. S&P says Chinese light vehicle sales will jump 9.9% in 2013, reaching the 20m threshold, and LMC Automotive says China’s passenger car market could hit 25m by 2019.

There is no doubt the German automakers have captured the Chinese imagination, offering premium products at higher prices well suited for these markets – strong, high-end luxury brands that appeal to the burgeoning middle-class.

And VW epitomises the foresight they have shown in China, where every fifth new passenger vehicle sold is now a VW. It has 12 plants in the country and plans seven more.

Challenges remain

Despite this eastern promise, there is little doubt 2013 will be challenging.

IHS Global Insight reported a marked decline in the German passenger car market in March, with sales down 17.1% year on year to 281,184 units. As if to underline this, Volkswagen’s first-quarter operating profit dropped 26%. Daimler has hinted that it might need to revise its full-year profit goal, and BMW expects flat group earnings.

But the fundamentals – like the Zeitgeist – remain in top gear, and both Daimler and VW still expect new models to throttle forward a pick-up in the second half of the year.

VW plans 60 new models this year, is discounting aggressively, and is standing by targets to match the 2012 record operating profit of €11.5bn – and to push sales to new record levels.

“It’s difficult to identify challenges when everything seems to be going so smoothly and so well. In comparison to their peers they are probably in a very luxurious position, where the only serious challenge is how to optimise things,” said SG’s Wagenknecht.

 

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