How are Korean automakers positioned amid the electrification trend?
We believe they are well positioned in the long-term shift to electric vehicles (EV) and that their approach towards electrification is proving to be effective. This is enabled by Korean automakers’ efficient investment strategy and production flexibility, which provides structural advantage against some global competitors that are struggling with EVs. Their efficiency in investment and R&D allows for competitive electric vehicle (EV) offerings at higher profitability, compared with legacy original equipment manufacturer (OEM) peers. Flexibility of production is another strength as the Korean OEMs can switch between internal combustion engine (ICE), full hybrid and EV on a single production line. This minimizes overhead cost and idle capacity risk as global EV demand grows in a non-linear fashion.
A modest normalization, but better than feared
We find that investors are generally pessimistic on the sector's earnings outlook, however, we believe the Korean automakers can be more resilient than the industry. A more shareholder-friendly return policy is a possibility given their strong cash generation. While we agree the profits of Korean automakers have indeed peaked in 1H23, our views are milder than what market fears (i.e., the volumes and earnings of Korean automakers potentially being at risk as EV demand slows) given the still-low inventories in select markets, strong demand for full hybrids and relatively favorable geographical exposure of Korean automakers.
Korean automakers have high exposure to North America, where the visibility on car pricing and product mix is better due to lower inventories. Elsewhere in the world, global investors worry about intense competition in China. However, this is no longer a headwind for the select Korean automakers who have already downsized mainland China business since 2017. The lack of China exposure improves earnings visibility relative to other OEMs. Specifically on EVs, we expect significant cost savings from the decline in battery material prices. ÃÛ¶¹ÊÓƵ proprietary analysis of battery cell cost based on ÃÛ¶¹ÊÓƵ Evidence Lab groundwork indicates that automakers will be able to save around $30/kWh in 2024E compared with 2022. Given the pack size of 78kWh for a long-range vehicle and average price of around US$40,000, improvement in profit could be around US$2,300 per car or 6% on operating margin, which is not insignificant.
Upside and downside scenarios for Korean OEMs
In our upside scenario, we assume consumer demand to be more resilient than our base case, especially in the US. Whilst the ÃÛ¶¹ÊÓƵ top-down base scenario assumes a (shallow) US recession in mid-2024, our upside scenario assumes no US recession. This would lead to tighter auto supply-demand balance and prolonged low inventory levels. Stronger US economy could translate into stronger US dollar vs Korean Won, positive for Korean exporters. Better consumer demand could lead to stronger EV sales growth, in which case the Korean OEMs could choose to increase EV production volume vs ICE. The profit margin impact would be slight negative due to EV mix rising, but more than offset by industry incentives being higher. OEM operating profit would be flat/marginally up YoY for 2024E.
In our downside scenario, we assume consumer demand to be weaker than our base case. This could lead to higher inventories and incentives in the US market. At the same time, Korean economy's recovery is more sluggish, leading to weak domestic sales. The result of this would be weaker price/mix for the OEMs, eroding the pricing power. Demand would be weak not only for EV but also ICE cars, turning sales volume into negative YoY territory and weigh on profitability. EV OEM operating profit may see ~20% decline YoY for 2024E in such scenario. Whilst our base case assumes a temporary slowdown in EV sales before re-accelerating again from 2025, our downside scenario assumes a more prolonged EV slowdown.Â
