Consistent growth, trade diversification should boost Mexico's automotive industry

In January 2017 Ford Motors announced it would cancel its proposed $1.6bn investment in a new assembly plant for its Ford Focus model in the Mexican state of San Luis de Potosí (see analysis). International media reported that Mark Fields, CEO of Ford Motors, stated that the decision was based, in part, on the fact that falling demand for small cars meant that supply could easily be ramped up at the firm’s Flat Rock plant in the US state of Michigan. Nevertheless, the move was seen by many as a sign that US President Donald Trump’s critical stance towards the North American Free Trade Agreement (NAFTA) was leading major firms to reassess their investment strategy towards their Mexican assets. Later in the month President Trump floated the idea of a 20% import tariff on Mexican goods, spreading further uncertainty among Mexican exporters.

However, it is by no means certain that the Ford cancellation is a negative indicator for the Mexican automotive industry. In early 2017 many carmakers and parts producers restated their commitment to Mexico as the country seeks to become a global leader in the industry, with the press reporting in February 2017 that China’s Anhui Jianghuai Automobile and Chori Company plan to invest over $200m in an SUV plant in Hidalgo state. Whereas the depreciation of the peso can be seen as both as a blessing and a curse, the unpredictability of the situation is a cause for concern for many car companies, whether distributors or exporters. Hirokazu Maruyama, CEO of Isuzu Motors Mexico, told OBG, “Currency volatility has put significant pressure on the sector while companies are trying to maintain prices to cover losses and keep market share.”

Vehicles

In 2014 Mexico overtook Brazil to become the world’s seventh-largest producer of motor vehicles. In 2000 the country produced 1.28m cars and 656,000 commercial vehicles, according to the Mexican Automotive Industry Association (Asociación Mexicana de la Industria Automotriz, AMIA). In 2015 these figures had jumped to 1.97m and 1.6m, respectively, and from January to November 2016 the country produced a combined 3.22m vehicles, up 1.5% on the previous year’s figure. According to figures from industry data agency National Auto Parts Industry (Industria Nacional de Autopartes, INA), 79% of vehicle production is exported, and the terminal and auto parts industry represent 3% of Mexico’s GDP and around 18% of manufacturing GDP, with the country’s 20 production complexes spread across 14 different Mexican states.

Most global car manufacturers from the US, Europe and Asia already have a presence in Mexico, with the two largest, Nissan and General Motors, having a combined 45% market share, according to figures from trade and investment promotion agency ProMéxico. Audi and KIA Motors established new plants in the country in 2016, and in 2017 Audi’s production is expected to reach over 147,000 light vehicles, while KIA’s Nuevo León plant will help it reach more than 172,000 light vehicles. In 2015 AMIA estimated that Mexico could produce 5m vehicles per year by 2020. “Given the expansion plans of the country’s automakers, the 5m car goal is a realistic target for Mexico,” Gabriel López, president and CEO of Ford Motors México, told OBG.

Best-Laid Plans

The rapid growth of the Mexican automotive industry came about as a result of the country’s implementation of NAFTA in 1994, as well as its geographic location and deep labour pool. Between 1989 and 2016 Mexico’s share of North American vehicle production has greatly expanded, from 5% to 25%. In addition, state governments offer generous incentive packages on projects for manufacturers looking to set up shop. The state government of San Luis Potosí, for instance, offered Ford exemption from payroll taxes, as well as exemption from property taxes, and free land and construction licences for 10 years. “Mexico’s strategic location, near to both the world’s largest automotive market, the US, and high-growth markets in South America, gives it the edge,” Alexander W Wehr, executive director of BMW in Latin America and the Caribbean, told OBG. “In addition, it has a strong existing supplier network and a well-trained labour force.”

Despite the obvious attractions of the Mexican market, a heavy dependence on the US for exports has left the industry particularly vulnerable to potential shifts in trade policy in that country. The cancellation of the Ford plant in San Luis Potosí not only meant the loss of an anticipated 2800 direct jobs by 2020, but was also seen as a sign that US carmakers were taking seriously President Trump’s pre-election threat to penalise local firms that relocated production to Mexico.

Since early 2017, however, support from carmakers has been strong. A silver lining of Ford’s withdrawal was that the firm announced it would add 200 jobs at its Hermosillo plant, where it makes its Fusion and Lincoln MKZ models. Meanwhile, General Motors confirmed in January 2017 that it will move production of its GMC Terrain SUV from Ontario to its existing Mexican plants, and Ford will still push ahead with the 2017 opening of engine and transmission plants in Guanajuato and Chihuahua states. It is still unclear whether President Trump’s administration plans to treat European and Asian carmakers with plants in Mexico the same as US firms. In the days following the Ford announcement, Germany’s BMW restated its commitment to its new plant in San Luis Potosí, and KIA representatives said they would continue to export from Mexico, although the company was devising contingency plans.

Way Ahead

In March 2017 there was still uncertainty over US trade policy and the future of NAFTA, but industry leaders close to the Mexican government’s negotiation team believe there are ways to avoid the imposition of a 20% import duty, which would ultimately be shouldered by consumers in the US. “The imposition of an import tax would add between $2000 and $3000 to the price of vehicles sold in the US, and have potentially serious legal ramifications for the US given its membership in the World Trade Organisation,” Alberto Bustamante, director of foreign trade and standardisation at INA, told OBG. One alternative position proposed by Mexico is that local content requirements for cars produced within NAFTA be strengthened from 60% to between 70% and 75%. Under such a scenario, imported car parts from outside of the trading bloc – primarily from Asia – would likely be the ones to lose out.

Other Markets

Mexico has a total of 12 free trade agreements with 46 countries, including with the EU and key South American markets, and in recent years exports outside of NAFTA have increased markedly. However, Mexican vehicle exports of 145,000 to Europe, 126,000 to Latin America and 80,000 to Asia are a drop in the ocean compared to the 2.24m sent north of the Río Grande. “Diversification of export markets is a long-term goal for the Mexican automotive industry,” said Bustamante. “Right now we are tied to the US.”

Even so, the opening of new markets, combined with a refocus on domestic sales, could help take up some of the slack in the event of further trade complications. Internal demand for vehicles is booming. According to AMIA data, between January and November 2016, 938,000 cars and 473,000 commercial vehicles were sold in Mexico, which mean an increase of 26% and 17%, respectively, compared to the same period in 2015. “Mexico is no longer an emerging market when it comes to car purchases,” Radek Jelinek, director-general of Mercedes-Benz México, told OBG. “Mexicans are now buying luxury cars, and the country is not far behind developed markets in terms of demand for new technologies such as electronic and driverless vehicles.”

There are also opportunities for producers of buses and heavy vehicles. “Over the coming decade, Mexico will need to make large investments in public transportation systems and infrastructure projects to ensure sustained growth,” Enrique Enrich, director-general of commercial vehicle producer Scania Mexico, told OBG.

Parts

The relationship between the US and Mexico in the automobile segment is further complicated by the deep integration of the two countries’ auto parts industries. Over 60% of auto parts produced in Mexico are exported to the US, and around 40% of inputs used in vehicles originate from the US, making a tit-for-tat tariff increase highly impractical. Mexico’s domestic auto parts industry is an $85.5bn business, with harnesses, seats and engines being the biggest earners.

Tyres

According to Dublin-based data firm Research and Firms, the Mexican tyre industry is reporting strong growth, reaching 3.48m units in 2015, and is expected to maintain a compound annual growth rate of more than 10% in 2017-21. Goodyear, Continental Tire, Bridgestone, Pirelli and Michelin all have existing facilities or plants under construction, and the country’s capacity is set to increase dramatically over the coming years. One model many of these industry leaders have adopted is the production of premium tyres designed for both national and international markets. One particular inauguration due for 2017 is US firm Goodyear’s $550m factory in San Luis Potosí, scheduled for completion ahead of schedule in July 2017.

“As vehicles become more durable they require a greater number of tyre changes in their lifetime,” Martin Rosales, president and managing director of Goodyear México, told OBG. “As well as being close to export markets in the Americas, the cluster of automotive firms located in San Luis Potosí has a real and tangible effect both on the quality of the supply chain and – through the knowledge sharing it promotes – the human resources available,” he added.

Supporting Growth

Although in early 2017 the effect of political uncertainty from the US on the auto parts sector remained unclear, the collective investments from the world’s major tyre firms mean significant growth in tyre manufacturing capacity in Mexico over the next five years. Despite recent expansion, many opportunities remain in the auto parts segment. “In terms of tier-1 suppliers, Mexico has no shortage of quality companies,” López told OBG. “In terms of tier-2 and 3, some things are lacking, but it is only a matter of time before companies fill these niches.” For René Gronau, CEO of Komet de México, a manufacturer of cutting tools for the automotive industry, the sector’s long-term fundamentals have remained strong. “Growth in the automotive industry has been fuelled by the high level of human capital available in the country, with talented and creative engineers and technicians,” he told OBG. “Further gains in labour productivity will enhance the country’s image as an attractive centre for advanced manufacturing. Despite a slight decrease in activity in 2016, the arrival of major international manufacturers should create significant opportunities for businesses along the supply chain.” In their interest to improve the talent pool, some foreign firms have developed training centres, such as VW and Audi.

Indeed, the sector remains an important contributor to economic growth in the country. Jorge Contreras, president and director-general of training institute Grupo Centro de Estudios Diesel y Vehículos Automotores, told OBG, “From auto parts makers to original equipment manufacturers, all companies of the production chain of the automotive industry are of utmost importance as they generate employment and are central to the economic development of the country.”

Down The Road

As the new government in the US defines its trade strategy over the course of 2017, the uncertainty that overshadowed the Mexican automotive industry during the first months of the year should dissipate. It remains possible that US carmakers may face pressure to prioritise job creation in the US, which could have a knock-on effect on their Mexican investments; however, with an estimated 40% of materials within Mexican-made cars originating from the US, there may be some resistance from auto parts makers north of the border to break existing production chains.

Moreover, Asian and European auto parts producers are less likely to be affected and, given the highly integrated nature of the auto parts industry in North America, a tariff war looks fairly improbable. Mexico’s strategic location and talent pool will allow it to retain its position as one of the world’s leading automotive producers, and if there is a need refocus on new markets, the industry will emerge all the stronger.