In this automotive review our experts share their perceptions of how COVID-19 has impacted both the upstream and downstream sectors of the industry, and the benefits which can be generated by claiming research and development expenses credits and the FCA response ban on motor finance discretionary commission model. We also include insight into our annual automotive report in collaboration with Cox Automotive.
To stay informed on the state of the industry, read our automotive review.
The automotive upstream industry, manufacturing, is global, using just-in-time supply chain processes to source components for vehicles across continents and reduce working capital and inventory to a minimum. This protocol curtails trapped cash in the business and maintains lower costs across the production process. COVID-19 has directly impacted the shortage of semiconductors and other vehicle component raw materials.
Downstream, dealers and customer-facing companies have also experienced rapid change, being forced to retail online. To manage the challenges it faced, the upstream sector has reviewed the supply chain and production processes to cope with the closure of factories and reduce costs in order to enhance earnings.
The profits of most major original equipment manufacturers (OEMs) were only lightly impacted by the difficulties of the last 18 months.
There was also limited impact on the supply chain, with small amounts of disruption, even in China, where coronavirus first appeared. However, by mid Q1, this changed, and factories closed as lockdowns were imposed around the world. By Q2 2020, profits were falling dramatically and, in some cases, tipped into significant losses. To calculate this, we've used normalised earnings as this does not account for any exceptional items that may have affected profits.
General Motors, Toyota, Kia, Tesla and Hyundai remained in profit in Q2 2020; however, Hyundai went on to make a loss in Q3 2020.
With factories closed and retailing vehicles also on hold, there is little automotive OEM companies could do to avoid impact on their profits: cost reductions were quickly enacted, and staff put on furlough where possible. The specific impact of these problems, however, did vary between companies.
Tesla continued to make a profit, delaying the closure of production in its American US Fremont plant for as long as possible, and reopening it as quickly as possible. The business also quickly diverted production to its plant in China.
Notwithstanding this, caution is needed when using normalised numbers as the business continued to benefit from other OEMs purchasing regulatory credits (also known as environmental credits). This removed the income from regulatory credits to leave only income generated from the production of vehicles, putting the business into loss in Q1 and Q2 2020. Vehicle sales nevertheless continued to increase and it was not until Q3 that Tesla’s normalised EBIT ex regulatory credits started to make profits.
Even excluding regulatory credits, this was a strong rebound for such a young automotive OEM company. That rebound continued into Q2 2021 with a strong performance in automotive revenue, up 97% YoY.
Normalised EBIT also increased due to revenue growth, lower costs, and rising profits in non-automotive areas of the company - now making it more difficult to split our automotive from non-automotive. However, environmental credits declined, which is expected to be a long term trend.
In Q2 2020, the OEMs responded quickly to the change in the market by making cost reductions. Despite losses in Q2 2020 of US $6.1 billion, Ford’s performance improved in Q3 2020 with a strong rebound to US $2.8 billion profit caused by its focus on high-value vehicles, such as SUVs and pickup trucks.
There was a strong increase in demand for these vehicles after the first few months of coronavirus. Furthermore, Ford’s cost reduction plan, which started in 2017/18, started to realise value. This improvement in performance continued until Q1 2021, but there was a drop off in normalised earnings in the second quarter of that year - supply chain issues caused a shortage of vehicles.
Stellantis also experienced a strong rebound: from a US $0.96 billion loss to US $2.2 billion profits in Q3 2020. The company benefited from continued cost reductions from its recent acquisitions: Opel/Vauxhall and FCA.
Nissan Motor Co. was heavily affected by the lack of production in calendar Q1 and Q2 2020, making large losses of US $94 billion and US $153 billion respectively. Nissan was already struggling in the US market before coronavirus, and this was compounded by the drop in production over Q1 and Q2 2020.
Nevertheless, the cost reductions meant that the business generated less severe losses than investors had expected. Further cost cutting took place over the period and vehicle volumes returned. By Q4 2020 Nissan was making profits, but this was short lived. The company returned to a loss in Q1 2021 and the return once again to profit in Q2 2021 (July 2021 or Q1 2021 for Nissan).
This increase was due to the rise in retail sales revenue, up globally 61% year on year, even though the number of units sold was lower and stock supply was starting to become an issue for the company.
As 2020 ended and Q1 2021 began, most of the OEMs were generating profits, with the exception of Nissan. The trend in Q2 2021 has been positive, with all OEMs now making profit.
You can see an illustration of the growth from Q1 2020 to Q2 2021 below.
Volkswagen and Toyota had strong performances in Q1 2020 and Q2 2021. In Q2 2020 was the most profitable of all the OEMs, but Toyota, which has managed to increase its supply of semi-conductors, saw a strong performance in Q2 2021. Volkswagen's profitability suffered more from the lack of semi-conductors.
It's still important to note that although all automotive OEM companies performed well in Q1 2021, there are are some remaining causes for concern. In addition to semi-conductors, there are shortages in raw materials such as natural rubber - costs for these materials, as well as shipping and logistics, are also rising.
The big risk for the remainder of this year is the semi-conductor shortage. Some OEMs have indicated that it will continue into 2022.
With little respite from this and other issues in the supply chain there is a risk that profits might once again come under pressure in the remainder of 2021 and early 2022. This will filter up from the OEM's tier one-four parts' suppliers to distribution and retail.
This is becoming apparent as the shortage of new vehicles is starting to impact the used car market.
If you would like more information on what's happening in the automotive industry get in touch with Owen Edwards.
The RDEC is a great incentive for pursuing innovation. These regimes can give automotive companies between 10% and 33% cash return on expenses for eligible projects and activities.
It's therefore surprising that in spite of the maturity of this regime, a recent survey of the automotive sector revealed that 70% of companies think they're underclaiming on eligible innovation.
The automotive industry is heavily involved in research and development (R&D): from project inception to production process approval, and sometimes beyond. Many companies do claims on the core activities: vehicle assembly and component design, but can often overlook other eligible areas or processes.
We've identified three frequent causes of underclaiming:
1 Poor confidence in articulating the project's technological challenges
2 Absence of data and internal resources to record the project's activities and costs
3 No evidence of the R&D effort around the periphery of the core project
Our relationships with automotive companies has revealed a clear solution for resolving the first two of these problems. We frequently support companies by helping them collate their available information and data to build a methodology, thereby limiting the internal resource needed to create the R&D claim.
In general, R&D activities are well documented and a product must pass several stage gates before it is approved for start of production. Introducing a new model, or model face lift, regulatory change, modification or improvement of a production process; and changes to materials or components, must all undergo multiple levels of approval. This process generally follows a standard and well-documented methodology, which is evidenced to provide an audit trail for it. Much of the time this information can be enhanced to provide a robust substantiation pack for an R&D tax claim, so you can optimise your claim without any additional admin burden potentially required to add projects and activities to it.
By creating a well-documented standardised approach you can leverage previously captured data and available within the business.
Addressing the third issue follows on from the success of building a claim methodology using existing processes and data sets. The time and effort saved in documenting the majority of the R&D activity can be redeployed into reviewing and challenging other areas of activity which fall outside of the formal stage-gated process, or into areas where you're diversifying. These can be ad hoc projects, pre-project activity and blue-sky R&D, which frequently includes activities eligible for claim.
Even if you can't identify any current work eligible for this credit, it's not too late to submit claims for previous projects. HMRC accepts claims submitted for projects from the two preceding accounting periods: e.g., to claim for the period ended 31 December 2019, you will have to make an RDEC claim by 31 December 2021.
If you’d like to discuss any aspect of optimising your R&D tax claims, contact Lindsey Copland in our innovation tax team.
For the fourth year running, we have collaborated with Cox Automotive to produce an annual Insight Report, providing a comprehensive and informed look at the most important trends and topics influencing the automotive industry today.
In this report, our experts share their analysis across five key opportunities for the automotive sector.
At the start of the first lockdown, we anticipated a high rate of insolvencies in H2 2020. This outcome was mitigated by the government's actions to provide financial support to companies throughout this period.
The extension of the furlough scheme supported job security until September 2021. With better than expected liquidity in the economy, this has enabled some companies to make new acquisitions.
Additionally, rumours that the government might have increased capital gains tax (CGT) at the March 2021 Budget — to bring down the public sector debt of £2.13 trillion — encouraged many company owners to accelerate plans to dispose of their business before this happened. Although Budget 2021 did not actually feature an increase in CGT, there is growing speculation that it might occur in the future.
At both ends of the spectrum – the upstream (manufacturing) and the downstream (customer facing service companies) – consolidation is taking place, exacerbated by wide-ranging changes in the automotive market.
Further harsher financial penalties for missing emission regulations are forcing automotive original equipment Manufacturer (OEM) companies into heavy investment in new power trains and light weighting to reduce the emissions of their new vehicles.
This investment impacted their profits and, in turn, forced them to reduce costs and restructure.
Consolidation and the benefit of economies of scale, as seen in PSA’s acquisition of Vauxhall/Opel can provide some cost savings. Some consolidation is also expected in the coming year as the automotive OEM companies look for a route to generate greater market share and lower costs.
We expect further consolidation in the downstream sector in several areas. Dealer groups will continue to grow in size. Meanwhile, used car supermarkets are set to increase their vertical integration into other areas of the market: vehicle remarketing (Cazoo acquiring Smartfleet) and car subscription (Cazoo acquiring Dover).
We believe that leasing and fleet companies will also consider strengthening their position through consolidation in order to gain economies of scale, as well as through the provision of additional services, such as the move into value-added services: e.g., Mobility-as-a-Service.
Among the dealers, we can see that consolidation has continued over several years. The number of dealer outlets has shown a gradual decline of 6.5% over the last five years. The franchise outlet for European volume brands have lost c.14% of their franchise outlet over the last 5 years. Citroen has seen a reduction of 26.2% of their outlets over the last 5 years, and Vauxhall has seen a decline of 20.3% over the last 5 years.
Graph: Total UK Franchise dealer outlets – Main outlets
If we go back to the financial global recession of 2007, acquisitions in 2008 among car dealers and vehicle repair companies dropped, with a strong bounce back in activity in 2009, possibly because of pent-up demand.
Graph: Year motor retail acquisition 2007 to 2020
Most dealerships are asset-rich and could be valued in different ways. The approach to general retail assets is a valuation of enterprise value (EV) to earnings before Interest tax depreciation and amortisation (EBITDA). With the large number of assets held by a motor retailer – including freehold property, new and used vehicles and spare parts inventory. So, it's important to ensure full shareholder value is achieved.
Dealers should be valued as follows: net asset value, plus a goodwill multiple of EBITDA. This takes into consideration both the asset-value of the business and its profitability.
It should be noted that the quoted Plc companies on the London Stock Exchange are not valued by the same method because they have a quoted market capitalisation — therefore, adding net debt equates to EV, which is then divided by EBITDA. Also, many equity funds need to hold shares in certain market sectors to maintain balance in their portfolio.
Motor retailers are in the general retail sector. Index tracker funds and some portfolio fund managers will have to allocate a proportion of their fund to general retail and, within this sector, the standard valuation process is either EV/EBITDA or price earnings ratio. Recently, Inchcape Plc – a distribution company – has moved from the general retail sector to support services.
In summary, non-quoted motor retail companies are valued on a net asset + EBITDA goodwill bases.
Guaranteed vehicle buy-backs, correctly-valued used vehicle and parts stocks, onerous employment contracts, and a strong and healthy relationship with the OEMs.
This list is not exhaustive, but it does provide an indication of the qualities in a business that can command a higher price.
When buying, selling, or consolidating a business, it's good practice to engage a professional adviser early in the process, as it's difficult to negotiate the price upwards from an indicative base. There are also many pitfalls throughout the process, which an adviser can help sellers avoid.
If you would like more information about the auto retail sector, assistance in the disposal of your business, or purchase of incremental assets, get in touch with Owen Edwards.
