How Trump Tariffs Could Impact The U.S. Auto Industry

President Trump recently lent his support to the Commerce Department recommendation for raising import tariff on aluminum and steel. The new tariff of 25% on imported steel and 10% on imported aluminum will go into effect in 15 days on imports from all countries except Canada and Mexico, with which the North American Free Trade Agreement (NAFTA) renegotiations are on.

Canada And Mexico

The U.S. has taken a hard stand on NAFTA, which was initially signed in 1993. There is a demand to allow the U.S. government to review and possibly overrule the decision of the arbiter in disputes between an investor state and the government of the country where the investment is made. There is a proposal to allow NAFTA to expire in five years unless all three countries agree to renew it.

There is an attempt to limit liability for Internet companies like Google (NASDAQ:GOOGL), Facebook (NASDAQ:FB) and Comcast (NASDAQ:CMCSA) when they host or transmit online content. There is also an unquantified demand to strengthen the Auto industry’s “rules of origin” (minimum percentage of a vehicle’s production to originate in the U.S.).

There are special demands of Canada, which is the largest exporter of steel to the U.S. while protecting some of its own industries such as milk & other dairy products and softwood lumber. If the demand to open up these markets isn’t met, Trump will pull out of the NAFTA, in which case, the high import tariff on Canadian steel will kick in.

Mexico is the new low-cost manufacturing location after Asia, with a proximity advantage, which is the main bone of contention with it (other than illegal immigration). But the last round of negotiations weren’t targeted at Mexico.

So the tariff increase for Canada and Mexico is basically something the U.S. intends to use as leverage to get more favorable NAFTA terms (6^th round negotiations are slated for this month).

The EU

The EU, especially Germany is where many of the big auto companies are located, so this could be when talks of a free trade deal resume (talks were temporarily paused after President Trump’s election but both sides have been warming to the idea in recent times).

The U.S. currently charges a 2.5% tariff on passenger cars and 25% on commercial vehicles while the EU charges 10% on passenger cars and 22% on commercial vehicles. This is likely where Trump is attempting to find parity.

European Commission President Jean-Claude Juncker has threatened to increase tariff on popular U.S. goods like Harley Davidson motorcycles, Kentucky bourbon and Levi's jeans, to which Trump tweeted that there would be a retaliatory increase in tariff on EU cars exported to the U.S.

China

The main issue for America is China, one reason why many issues are also called security issues. The country has been producing a ton of steel that is creating an oversupply situation in the global market, thus driving down steel prices. The U.S. doesn’t buy much of its steel from China, but it is of course impacted by the inventory glut. And China is aggressive in getting what it wants.

Its foreign minister, Wang Yi, responded to the news with “China would have to make a justified and necessary response.” He also said that trade wars weren’t the best way to solve problems. “Especially given today’s globalization, choosing a trade war is a mistaken prescription. The outcome will only be harmful.”

Which Brings Us to the Other Side of the Picture

Companies, markets, trade groups, some congressmen and others are opposing the move because the steel industry employs a relatively smaller number of people than the automotive industry, which will be inordinately affected by the rise in raw material prices (steel and aluminum). And while they will now have to use more expensive raw material, their global competitors with access to cheap Chinese (and other) steel would be more competitive, thus leading to a negative impact on exports.

Despite the government’s concerns about the inventory glut, auto makers are wary about increasing raw material costs. Ford (NYSE:F) for instance says that steel prices are up 33% since the beginning of 2017 while aluminum (used in its F-Series pickups) is up 25%.

Also, many European auto makers like Volkswagen (DE:VOWG_p) have U.S. operations, from where cars are also exported. They too are big employers in the U.S. It can’t be helped that Americans like European cars better than Europeans like American cars. Increasing costs for these employers won’t be positive for America.

Auto Makers Are Responding

McLaren Automotive: "While North America is our biggest single market, as a luxury-automotive brand who retails in well over 30 markets, our long-standing policy is to balance our sales globally."

Toyota Motor (NYSE:TM) : "...The majority of the steel and aluminum we directly purchase is from right here in the U.S." "Nonetheless, the administration's decision to impose substantial steel and aluminum tariffs will adversely impact automakers, the automotive supplier community and consumers as this would substantially raise costs and therefore prices of cars and trucks sold in America." "The risk is for the end customer, who'll feel the financial impact because he'll probably pay more."

PSA Group, the maker of Peugeot, Citroen and Opel: "It's better that we have an open world where we can trade peacefully."

Volvo (OTC:VLVLY) CEO Hakan Samuelsson said that tariffs could affect its plans to export from its under-construction building in South Carolina (half the 4,000 projected jobs are for exporting S60 sedans and XC90 crossovers).

Volkswagen (OTC:VLKAY) CEO Matthias Mueller: "I think the American government knows that in the past we had agreements like NAFTA that shouldn't just be destroyed on a whim.

"We all put our efforts into globalization in the past decades, and I think we shouldn't give up that idea so easily."

Ford's Armstrong: "We are advocates of free trade and hope that's how it plays out."

Industry Groups Are Also Responding

The American Automotive Policy Council:. "We are concerned with the unintended consequences the proposals would have, particularly that it will lead to higher prices for steel and aluminum here in the United States, compared to the price paid by our global competitors.

"This would place the U.S. automotive industry, which supports more than 7 million American jobs, at a competitive disadvantage."

Cody Lusk, President of the American International Automobile Dealers Association: “These proposed tariffs on steel and aluminum imports couldn’t come at a worse time.

“Auto sales have flattened in recent months, and manufacturers are not prepared to absorb a sharp increase in the cost to build cars and trucks in America.”

John Bozzella, President of the Association of Global Automakers (The group represents companies including Japan’s Toyota, Germany’s Bosch and South Korea’s Hyundai Motor Co): While the Trump administration did good by cutting taxes late last year, the tariffs are likely to “nullify many of the benefits” as vehicle prices go up. “Investments earmarked for new products and plants will instead be funneled to pay for rising steel and aluminum prices used in existing products and facilities.”

VDA, a German Association of the Automotive Industry: German car factories in the U.S. have together produced 804,000 vehicles last year, of which 430,000 were exported. On the other hand, the number of German cars imported into the U.S. is down about 20% since 2014, to 494,000 vehicles.Since 2013, brands like Mercedes, VW and BMW have added 5,700 jobs, increasing U.S. staffing to 36,500 people.

All the auto stocks mentioned above except Ford have a Zacks Rank #2 (Buy). Also see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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