Last month, U.S. auto giants Ford Motor (F 0.66%) and General Motors (GM -0.17%) cut their 2018 earnings forecasts, blaming (in part) increases in commodity costs related to steel and aluminum tariffs.
If President Trump has his way, an even bigger tariff headwind could be coming soon. Trump is strongly considering imposing 25% tariffs on auto imports in order to reduce the U.S. trade deficit and encourage more domestic auto production. While no immediate decision is expected, tariffs levied directly on auto imports would take a huge bite out of the auto industry's profit.
That said, by driving up the cost of new cars, auto tariffs could also boost the value of used cars. This would bolster the profitability of Ford and GM's auto-lending subsidiaries.
U.S. automakers are not excited about auto tariffs
At first glance, it might appear that domestic automakers like Ford and GM would benefit from tariffs on auto imports. However, if the tariffs extend to Canada and Mexico (as proposed), then Ford and GM wouldn't be spared. Ford imports 21% of the vehicles it sells in the U.S. -- the lowest percentage of any major automaker -- while GM imports 39% of the vehicles it sells here. Additionally, vehicles manufactured in the U.S. use plenty of imported parts.
A 25% tariff on imports would drive costs up substantially. Automakers would probably have to accept both lower sales and lower profit margins. As a result, it's no surprise that automakers and suppliers (both domestic and foreign) have been united in opposing the proposed auto tariffs.
But rising used car prices could benefit their finance businesses
However, while tariffs on auto imports wouldn't be good for GM and Ford's auto manufacturing businesses, they would boost profits in the two companies' auto-lending businesses.
Ford and GM both have substantial auto lending operations. Image source: General Motors.
Both of the top two U.S. automakers have substantial financing businesses: GM Financial and Ford Credit. In 2017, GM Financial posted pre-tax earnings of $1.2 billion. Ford Credit is an even bigger cash cow, earning $2.3 billion before tax last year.
GM Financial and Ford Credit provide financing (sometimes subsidized) for car purchases and support the automakers' leasing programs. They also lend money to dealers to finance inventory purchases and upgrades.
The profitability of these finance units depends heavily on used vehicle prices. When a car comes back at the end of its lease term, the finance unit that owns the vehicle will book a gain or a loss depending on how its residual value compares to the projection made when the original lease was drawn up. Similarly, if a car buyer defaults on an auto loan, the loss to the lender depends on the eventual selling price of that (used) car.
Used car prices have spiked recently, most likely due to fears about tariffs driving up the cost of new cars. In July, used car prices were up 5.1% year over year, according to CNBC. Prices have risen further in August.
The increase in residual values has already driven further profit growth for GM's and Ford's financing units year to date. In the first half of 2018, GM Financial earned $979 million before tax, up from $585 million a year earlier. Meanwhile, Ford Credit posted pre-tax income of $1.3 billion, up from $1.1 billion in the prior-year period.
A port in the (potential) storm
GM stated in its Q2 earnings presentation that it expected profit growth at GM Financial to moderate in the second half of the year due to seasonally lower used car pricing and a higher supply of vehicles coming off lease. Ford likely has similar expectations.
However, used vehicle pricing is already moving counter to those conservative projections. If broad-based auto import tariffs become a reality, the resulting price increases could drive further gains in used vehicle pricing, boosting earnings at GM Financial and Ford Credit.
Auto tariffs are still likely to have a net negative impact on the top two U.S. automakers. That said, shares of both companies are already pricing in a lot of negativity at their current bargain valuations. If rising profits from their captive finance subsidiaries help cushion some of the blow from auto tariffs, Ford and GM shares could rebound over the next year or so.
