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Is the automotive sector ready for a no-deal Brexit?

The government claims the UK automotive industry is ready for Brexit. But can UK automakers really prepare for such a seismic change?

Brexit Source: Bloomberg

Is the UK car industry prepared for a no-deal Brexit?

The threat that Brexit poses to the UK and European automotive industry is well known. It was therefore a surprise when, last week, following a meeting with executives from across the industry, chancellor of the Duchy of Lancaster, Michael Gove, brazenly said the automotive sector had 'confirmed that they were ready' for Brexit.

What is Brexit?

The UK automotive sector has already spent equal to 13% of its annual research and development budget implementing plans for a no-deal Brexit. But the industry was quick to correct Gove and outline its readiness for the UK to make a clean break from the EU.

'Over £500 million has already been spent by UK automotive firms on 'no deal' Brexit contingency planning, but it is impossible to be fully ready for ‘no deal’. We need a Brexit deal to unlock investment and safeguard the long-term future of the sector,' said the UK’s Society of Motor Manufacturers & Traders (SMMT).

Mike Hawes, the chief executive of the SMMT, opted for a harsher tone when responding to Gove’s comments: 'European automotive is deeply integrated and the benefits of free and frictionless trade have helped our sector become one of Europe’s most valuable assets, delivering billions to economies and supporting millions of livelihoods across the EU. A ‘no deal’ Brexit would have an immediate and devastating impact on the industry, undermining competitiveness and causing irreversible and severe damage. UK and EU negotiators have a responsibility to work together to agree a deal or risk destroying this vital pillar of our economies.'

The message from UK automakers, in a nutshell, is that they have done what they can to get ready for a no-deal Brexit, but they can’t fully prepare.

What automotive stocks to watch amid Brexit

The automotive industry is extremely important for the UK. In 2018, the industry generated £82 billion in revenue, contributed over £18.5 billion to the UK economy, and accounted for more than 14% of the country’s total exports.

The UK’s industry is diverse. There are a number of premium and sportscar makers such as Aston Martin and Bentley, as well as those producing cars for the mainstream audience like Honda and Toyota. A considerable number of commercial vehicles are also produced in the country, which is an area dominated by Vauxhall. Then there are large engine manufacturers like Ford, which no longer makes cars in the UK, but still produces engines and transmissions. Over 2,500 companies supply automakers in the country, including giants like GKN.

Below is a selection of the key manufacturing sites in the UK:

Parent Oragnisation Location Sector
Alexander Dennis NFI Group Falkirk and Guilford Buses and coaches
Aston Martin Aston Martin Gaydon Cars
Bentley Volkswagen Crewe Cars and engines
BMW BMW Hams Hall Engines
Caterham Caterham Dartford Cars
Cummins Cummins Darlington Engines
Dennis Eagle Terverg RosRoca Warwick Commercial vehicles
Euromotive Euromotive Hythe Buses and coaches
Ford Ford Bridgend and Dagenham Engines
Honda Honda Swindon Cars and engines
Infiniti Renault-Nissan-Mitsubishi Alliance Sunderland Cars
Jaguar Land Rover Tata Motors Castle Bromwich and Wolverhampton Cars
Jaguar Land Rover Tata Motors Solihul and Halewood Cars
Leyland Truck PACCAR Leyland Commercial vehicles
Lotus Geely Norwich Cars
LEVC Geely Coventry Commercial vehicles
McLaren McLaren Woking Cars
Mellor Mellor Coachcraft Rochdale Buses and coaches
MINI BMW Oxford Cars
Morgan Morgan Motoro Co Malvern Cars
Nissan Nissan Sunderland Cars and engines
Optare Hinduja Group Leeds Buses and coaches
Plaxton NFI Group Scarborough Buses and coaches
Rolls-Royce BMW Goodwood Cars
Toyota Toyota Burnaston Cars and engines
Toyota Toyota Deeside Engines
Vauxhall PSA Group Ellesmere Port Cars
Vauxhall PSA Group Luton Commercial vehicles

(Source: SMMT)

How will a no-deal Brexit impact the automotive industry?

Tariffs will put up costs, and mass producers are most at risk

Trade between the UK and the EU will be dictated by World Trade Organisation (WTO) rules if there is a no-deal Brexit. This would impose a 10% tariff on cars that are bought or sold overseas while the average tariff on car parts crossing borders would be 4.5%, according to government figures. This will introduce considerable costs to producers: almost 80% of all UK-made cars are exported and sold overseas, with over 50% going to the EU. In turn, around 86% of all the vehicles purchased in the UK are imported, with 70% coming from the EU.

This will pose more of a problem for producers catering to the mass market rather than those making luxury cars for the affluent, who are in a better position to absorb additional costs. Considering low-end automakers make an average profit margin of just £450 on a £15,000 car, this has the potential to wipe out their entire profit margin. This means automakers would have no choice but to pass on the costs to consumers, making UK-made cars more expensive and less competitive. Europeans, the number one buyers of UK cars, are far more likely to opt for a cheaper, EU-made model after a no-deal Brexit. A paper released by the House of Commons Business, Energy and Industrial Strategy Committee last year (hereon called the HoC paper) warned sales of UK-produced cars to the EU could fall by 19% in such a scenario.

Higher costs and fewer sales will ultimately make the UK a less attractive place to manufacture vehicles, which will gradually push manufacturing out of the UK and into other EU countries. Last year, after meeting then prime minister Theresa May, the Japanese ambassador to the UK said: 'If there is no profitability of continuing operations in the UK – not Japanese only – no private company can continue operations. So, it is as simple as that.'

UK-European supply chains will face severe disruption

The European automotive industry’s supply chain is highly integrated. A car can cross the border several times before it reaches the customer. Less than half of all the parts of a UK-made car are produced inside the country, with the majority coming from the EU. The majority of cars that are then built are shipped back to the EU to be sold.

If the UK leaves without a deal, then UK manufacturers will face a slew of non-tariff barriers that will slow the supply chain down and introduce higher administrative costs.

Just-In-Time manufacturing could come to an end

The supply chain is reliant on just-in-time (JIT) manufacturing and the ability for parts to seamlessly flow across the border. Honda’s factory in Swindon receives a truckload of parts every seven minutes, so any border checks threatens the vast amount of deliveries being made on a daily basis. JIT manufacturing makes all the difference when you consider mass-market producers are earning a profit margin of just 2% to 4%. For example, the constant stream of deliveries reduces the need to stockpile parts, meaning they don’t have to fork out for large warehouses. Right now, warehouses only stock around one-day’s worth of parts.

Honda has estimated that a 15-minute delay at the border could add around £850,000 in annual costs, which is a large sum considering its Swindon plant makes less than £10 million profit each year. The HoC paper said Ford will have to make 115,000 declarations for its imports each year, which could add up to £4 million in costs. GKN, which supplies car parts all around the world, would suffer the same problem and has admitted there would be a 'fairly significant impact' on costs.

Meanwhile, Aston Martin, which produces fewer cars and is less reliant on JIT manufacturing, has warned its cashflow could be affected if its cars are held at the border before they can be shipped to overseas customers.

UK automakers could suffer from the loss of European business

Over half of all UK-built cars are sold in other European countries and around 30% are sold in markets like Canada, Japan, South Korea and Turkey – trade with which is dictated through deals signed with the EU. That means eight out of ten cars exported out of Britain will be impacted by a no-deal Brexit and affected by tariff and non-tariff barriers. Therefore, UK-built cars will be more expensive to the majority of overseas customers.

Some have argued that the UK could sell cars in other markets after Brexit, offsetting any loss in EU sales. However, while the UK does export a significant amount of cars outside the bloc, particularly to the US and China, the EU is too important to lose.

'Membership of the EU has not been a barrier to expansion into overseas markets, either for volume manufacturers or for premium producers. The barriers are more economic and geographic. We heard that the UK tends to produce for the European market close by and caters for European tastes. The SMMT could not envisage a UK-based manufacturer trying to compete with the best-selling vehicle in the US—a Ford pickup truck—given the logistics that support manufacturing close to the market,' the HoC paper warned.

If sales of UK-built cars are hit by a no-deal Brexit, then this will hit the volume manufacturers the most. Toyota and Nissan sell the majority of their UK-built cars to other EU states, while Mini, Honda and Jaguar Land Rover sell more cars to non-EU countries, making them more resilient against the threats of a no-deal. UK-made commercial vehicles – a space dominated by Vauxhall – will also be significantly impacted by any tariff or non-tariff barriers considering 93% are shipped to the EU.

Toyota increases stake in Subaru to deepen partnership in search of new technologies

While volume producers predominantly sell in Europe the premium end of the market carries more global recognition and therefore sales are spread more evenly around the world. Aston Martin, for example, announced it would be opening a design studio in China last year, its first outside the UK, demonstrating where it believes future growth will come from.

Top export destinations for UK-built cars in 2018

Country Volume % of total
EU total 650,628 52.60%
Germany 102,349 8.30%
Italy 84,309 6.80%
France 80,610 6.50%
Belgium 48,502 3.90%
Spain 34,519 2.8%
US 221,184 17.90%
China 75,749 6.10%
Japan 40,830 3.30%
Turkey 28,022 2.30%

(Source: SMMT)

The depreciation in the pound is likely hurt automakers

The benefit of a weaker pound to British exporters has become well known since the 2016 referendum. Although a weaker pound could help counter tariff-driven price increases, all-in-all, it is not good news for car manufacturers. This will lower the cost of UK cars for overseas buyers, but it will also make the imported parts more expensive. Plus, UK consumers will not feel the benefit of a weaker pound, meaning this will not help the domestic market, which has already floundered since the referendum. Not only will UK-built cars be more expensive, but so will any cars imported from the EU.

The chief financial officer of Aston Martin said last year: 'I do not think we ought to be looking to rely on weak sterling as a way of feeling good about WTO.'

What has happened to the value of the pound since the Brexit vote?

UK regulation could diverge from the EU framework

Brexiteers have argued that the UK will continue to align itself with the EU when it comes to regulation of key industries to ensure that UK-made products are accepted by the bloc. However, leaving the EU on a no-deal basis means UK-built cars may not be recognised by EU regulation.

Mike Hawes of the SMMT has said there are 'no opportunities from deregulation or divergence', while the HoC paper from last year bluntly said it would be 'self-defeating to depart from the EU regulatory framework', adding that the 'UK market is not big enough to warrant the additional costs to manufacturers of meeting another set of standards'.

Access to talent could be hampered

The UK’s future immigration policy could also pose a problem for the country’s car manufacturers. The government has recognised that 'the ability to move employees from one plant to another through intra-company transfers is core to the business model of many multinationals operating in the UK'. Up to 10% of the UK industry’s staff are from other EU countries, but this can be as high as 30% for some individual businesses. If EU nationals are unable or unwilling to work in the UK after a no-deal Brexit, then there is a clear risk that the country will be left without the talent it needs to succeed.

Indeed, the Automotive Council has said that there are already thousands of vacancies in the UK car industry and that this is having a 'significant impact' on operations – a situation that a no-deal Brexit threatens to make worse. There is an argument that talent could be sourced from outside the EU after Brexit. While that is a possibility, it is unclear where the staff would come from, especially as the industry relies on higher-skilled labour from the EU compared to most other UK sectors.

Will Brexit mark the beginning of the end for UK car manufacturing?

The full impact of Brexit will not be fully understood until it happens, but the signs are already suggesting it could be catastrophic for the industry. Investment by manufacturers in the UK has fallen since the referendum, thousands of jobs have already been lost, and production has declined every year since 2016 to just over 1.5 million cars in 2018. The industry’s target to produce 2 million UK cars annually now looks unachievable, and the UK has not even left the EU yet.

'Overall, no-one has argued there are advantages to be gained from Brexit for the automotive industry for the foreseeable future. We urge the government to acknowledge this and to pursue an exercise in damage limitation in the negotiations. This involves retaining as close as possible a relationship with the existing EU regulatory and trading framework in order to give volume car manufacturing a realistic chance of surviving in this country,' the HoC paper warned.

To recap, a no-deal Brexit is the worst-case scenario for automakers in both the UK and Europe. Tariff and non-tariff barriers will ultimately raise the cost of production and these prices will undoubtedly be passed on to consumers. While a weaker pound could provide something of a cushion against that, it will not be enough to stop UK operations from becoming less competitive against other EU markets. This threatens to gradually push production out of the UK, which could be accelerated by any loss of sales to the EU. The European market will still be key for UK automakers even after a no-deal Brexit because of simple geography: European consumers tend to buy European cars, Americans love their homemade vehicles, and Japanese and South Korean cars dominate markets across Asia.

Brexit (especially a no-deal one) will cause havoc for all UK automakers and no company will be immune from the threat it poses. But those producing large volumes of mainstream models like Toyota and Nissan will feel it most, whereas those making niche or premium cars like Jaguar Land Rover and Aston Martin will be less impacted because of their globally diverse sales and affluent customer base.

Overall, the biggest threat of a no-deal Brexit is the huge increase in costs - and it couldn’t come at a worse time for the industry, which is already grappling with a seismic shift in the market. The crackdown on diesel vehicles and the emergence of electric and autonomous vehicles have forced them to accelerate investment in new models. Otherwise they could get left behind by the new breed of competition that has entered the market – namely cash-rich tech and ride-sharing firms including Uber, Google and Tesla.

Other key Brexit material

IG has analysed how Brexit will impact several different industries. Below is a collection of some of our most-recent Brexit articles:

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