Most global automakers will find it hard to expand their profit margins over the next few years as they come under increasing pressure to reduce prices amid strong competition. At the same time, potential disruption by Chinese automakers poses an extraordinary challenge to legacy OEMs' product mix, cost efficiency, and technology.

Growing affordability challenges and heightened competition have quickly made global automakers' reliance on premium vehicle sales a less effective buffer against margin erosion. Such reliance worked well to offset supply shortages over the past few years. Similarly, rated auto suppliers will find it harder to rely on increased content per vehicle to mitigate sluggish volume growth because of uncertainty over the pace of the transition to EVs and suppliers' less-established positions with Chinese auto manufacturers.

The slowdown in vehicle electrification makes it challenging for suppliers to balance EV investment against volatile volumes and to obtain compensation for foregone volumes and higher production costs. OEMs will have to weigh the benefits of a longer internal combustion engine (ICE) tail against emerging regulatory costs.

High labor and manufacturing costs remain a challenge for both automakers and suppliers as low raw material prices only partly offset these costs. This is evident from numerous profit warnings in recent weeks, especially from European OEMs and suppliers. Suppliers have to contend with more leveraged balance sheets, high funding costs, and lower cash conversion, which explains the higher incidence of negative rating actions compared to manufacturers. The credit outlook for suppliers remains challenging as negative outlooks now make up a little less than 20% of our global portfolio, up from 10% a year ago.

Toughening market conditions will gradually erode the strong rating headroom that most automakers have built up over the past few years on the back of pricing power and product-mix strategies that are now harder to sustain. This will limit ratings upside for these automakers until we have more visibility on their flexibility and competitiveness in terms of product offerings, launch timings, and cost agility. These factors will determine the future industry leaders and losers.

Global Production Momentum Abates

After a muted first half for global light vehicle production, we have adjusted our outlook for the full year downward (see table 1). OEMs are racing to trim fixed costs and lower production in an attempt to defend their margins by reducing elevated inventory levels and adjusting their output and product mix to suit a more cost-conscious customer base. As an example, Stellantis N.V. and Ford Motor Co. will need to exercise production discipline in the fourth quarter of 2024 to reduce inventory levels meaningfully toward their stated targets.

As a result, we have revised our forecast for global light vehicle production down to below 90 million units in 2024, a drop of 1%-2% versus 2023. We previously expected stable production.

Table 1

In 2025 and 2026, we expect that global production will see limited growth as OEMs realize the importance of right-sizing their output and footprint for a competitive market and sluggish growth. In our revised base-case scenario, global production in 2026 will still be more than two million units below 2018 levels. This could represent a major headwind for auto suppliers relying heavily on OEMs' sales, and they may need to adjust their production capacity further.

Demand Growth Moderates As Auto Sales Lag Global GDP

Global demand remains moderate in our base-case scenario. This reflects strong labor markets, as global economies have so far remained more resilient than we had expected, albeit with regional divergences. Economic growth in the U.S., is slowing, while it is recovering in the eurozone, and China faces headwinds from depressed property prices.

Because of sticky inflation and still-high interest rates, buyers globally are becoming more price-sensitive, leading automakers to include more entry-level options across their product segments. We expect buyers to prioritize affordability over luxury features. Such features could become increasingly commoditized in a highly competitive environment, especially considering Chinese automakers' increasing penetration of international markets (except for the U.S.).

This situation leads us to keep our sales projection for global light vehicles in 2024-2026 broadly unchanged versus our previous forecast of 1%-2% growth per year. Upside to our forecast could stem from a rebound in consumer sentiment in China, while downside could stem from a marked deterioration in labor market conditions in Europe and the U.S.

Pricing Pressure Is Less Disruptive Than We Had Anticipated Outside China, But Won't Help In 2025

We had expected increasing affordability issues linked to higher-for-longer rates and a higher cost of living to have a more severe effect on pricing in the U.S. and Europe than has been the case.

In the U.S., average prices of new vehicles declined by about 3% in the first nine months of 2024. We expect them to drop by about 6%-8% from their current levels through to the end of 2025, due to greater buyer incentives and lower pricing at dealerships. This is unlikely to have a meaningfully negative impact on our margin assumptions for U.S. automakers that have managed incentives and inventory better than the industry as a whole, or those that have a significant model pipeline due to launch in 2025 and 2026.

Prices of used vehicles in the U.S. declined by 5% between 2023 and September 2024, according to the Manheim Used Price Index, as inventory is normalizing and incentives peaked in August 2024 versus 2021. We now expect used vehicle prices to fall by 2%-3% between the end of 2023 and 2024, and by another 4% in 2025, after dropping by around 7% in 2023. This is because the supply of two- to four-year-old vehicles remains tight following three years of lower production.

In Europe, pricing pressure mainly centers on the battery electric vehicle (BEV) segment due to customer hesitancy and the abolition of subsidies in key markets like Germany and the U.K. The main support for BEV sales comes from fleet buyers, but this has done little to alleviate pricing pressure. Apart from BEVs, we see some pressure on OEMs' suggested retail prices, but acknowledge that this remains manageable thanks to low raw-material prices and the production efficiencies that accompany new generations of models. We expect pricing to act as a modest headwind in Europe in 2025.

In China, while the price war hasn't escalated in recent months, automakers have been upgrading their products while holding prices steady. They are also introducing more entry-level brands and models--such as Xpeng's Mona brand and Geely Auto's Galaxy E5 model--to compete for share at the low end of the market, where prices sit below Chinese renminbi (RMB) 150,000. This segment accounts for about half of total passenger vehicle sales.

The Chinese Market Wrestles With Demand Weakness And Premiumization

Weak consumer sentiment prevails in China. This is notwithstanding the trade-in program that the Chinese government introduced in April 2024 and strengthened in July. Assuming a moderate bounce-back in the fourth quarter of 2024, with the trade-in program gradually taking effect, annual sales growth will end up in the 0%-2% range at best, down from 2%-4% previously.

We expect this trend to continue in 2025, on the back of sluggish economic growth and the potential for the trade-in program to bring forward some of the demand from 2025 to this year. At the same time, some consumers may decide to purchase EVs in 2025 ahead of a rise in the purchase tax to 5% from 0% that the government has announced for 2026. All in all, we believe that demand is unlikely to accelerate before 2026, when we expect the Chinese economy to recover.

We see the increasing average market-suggested retail price in the Chinese market as an indicator of gradual premiumization (see table 2). Above-average growth of the premium market--as defined by S&P Global Mobility--supports this view. Compound annual growth has been more than 10% since 2018, versus -0.7% for the whole market. The premium market constitutes roughly 20% of the whole passenger vehicle market, twice the share in 2018. Chinese OEMs increased their share of this market from single digits to nearly 40% over 2018-2024. However, this is a price range that legacy premium OEMs and brands do not target.

Table 2

Below-average growth rates in the mid- and upper-premium segment could represent a missed opportunity for legacy premium OEMs and brands over the next two years. Such growth rates could be the result of China's weak economy depressing volumes and transaction prices, with discounts of 20%-30% on top-end models according to reputable Chinese auto platforms.

Because we think that China's macroeconomic recovery will only be gradual, we don't expect the situation to improve quickly. Moreover, in the medium term, we could see the emergence of new domestic champions ready to capitalize on consumer preferences in the areas of infotainment and advanced driver-assistance systems. This could lead legacy premium players to revise their long-term ambitions in a market where premium prices are becoming harder to justify amid ongoing technological innovation.

Tightening Emissions Regulation Will Place An Additional Burden On Product Mix-Based Strategies

Global sales of BEVs and plug-in hybrid electric vehicles (PHEVs) continued to grow by 24% in August (LTM). However, the momentum is uneven, with China (37%) and the U.S. (23%) driving growth, while Europe stumbles on the back of a weak German market. PHEVs have strong market appeal in China. The global light EV mix is close to our 2025 projections, at 19%-21% (see chart 1).

Chart 1

We had anticipated EV growth softening in Europe in 2024, but not declining. The decline will add to the margin pressure for European OEMs in 2025–2026, as they already have to slash average carbon dioxide (CO2) emissions from their fleets by more than 10% next year, from 107 grams of CO2 per kilometer in 2023.

As we don't assume that there will be a last-minute regulatory waiver in Europe, some OEMs (Volkswagen AG, Renault S.A., Ford Motor Co., and Mercedes-Benz Group AG) will see their 2026 credit metrics reflect regulatory stress deriving from a combination of:

• Regulatory fines;
• Bilateral pooling agreements to buy CO2 credits; and
• Margin dilution owing to some groups pushing unprofitable vehicles onto the market with large discounts.

Other manufacturers, such as Volvo Car AB, Tesla Inc., SAIC Motor Corp. Ltd., and BYD Auto Co. Ltd., might take advantage of the ability to sell emissions credits.

We expect environmental risk for automakers to step up in China, with the government requesting comments on a new policy called fuel-consumption evaluation methods and targets for passenger cars. This policy requires considerable reductions in ICE vehicles' fuel consumption to avoid negative credits, or the production of sufficient BEVs to offset the negative credits.

Noncompliance will either lead to fines or force automakers to purchase emissions credits on the market. We understand that none of the ICE models on the market can meet the fuel-consumption targets. This therefore represents an additional risk for traditional premium brands, considering consumers' preference for ICE vehicles over their battery-operated variants.

Whether regulation in the U.S. tightens from 2027 depends on the outcome of the November 2024 presidential elections, although the Environmental Protection Agency has already issued clear standards for vehicles over 2027-2032. Our base-case scenario for the U.S. still incorporates significant launches at more affordable price points in 2025-2027, reflecting manufacturer subsidies from the Inflation Reduction Act, investments in local supply chains, and tax credits. We believe that these factors will help reduce the significant gap between U.S. EV market share and that in Europe and China by 2027.

The change in market dynamics has not led us to adjust our short-term global EV scenario substantially, although we have slightly amended our forecast ranges for Europe and China (see table 3).

Table 3

Related Research

• Industry Credit Outlook Update Europe: Autos, July 18, 2024
• Industry Credit Outlook Update North America: Autos, July 18, 2024
• Industry Credit Outlook Update Asia-Pacific: Autos, July 18, 2024
• Autoflash EMEA: Suppliers Feel The Heat Of Low Volumes and Earnings Pressure, July 1, 2024
• Rated China Carmakers Can Take The Heat From European Tariff Hikes On EVs, June 17, 2024
• Credit FAQ: Why China Is At The Center Of Global Auto Conversations, June 11, 2024