After a booming year for the UK car industry, Stuart Apperley, director of automotive at Lloyds Bank, shares his views on the challenges and opportunities that lie ahead in 2016.

"According to a recent report by KPMG, UK car sales have now fully recovered back to pre-recession levels and production is expected to grow towards two million vehicles in 2017, a record level of output. This is being driven by a myriad of factors, including significant foreign investment, increased demand for premium British brands abroad and the success of personal contract purchase (PCP) products for dealer groups, helping to drive domestic demand.

"More than £7bn has been invested into UK production facilities by foreign-owned companies in the past two years. Nissan has led the pack, after manufacturing circa 500,000 Qashqai vehicles exclusively at its facilities in Sunderland. Following close behind is Jaguar Land Rover, whose plants in Castle Bromwich, Halewood and Solihull have collectively produced almost 450,000 vehicles. Toyota, Honda and Vauxhall all have manufacturing plants in the UK too. 

"The investment appears to be paying off, with the Society of Motor Manufacturers and Traders (SMMT) claiming a record 43 months of growth this October. It also predicts that 2017 will smash the previous record of 1.92m cars set in 1972. Despite the recent boom in the sector, as we move into 2016 there is a host of new opportunities and challenges that automotive manufacturers will need to be cognisant of in order to fuel further growth.

Market Uncertainty

"Despite the uncertainty around a possible Brexit, we’ve continued to see investment in 2015, with Honda funnelling £250m into a global manufacturing hub for the Civic earlier in the year. However, the recent economic slow-down in China may impact confidence levels and investor appetite as we move into the first half of 2016.

"China was the largest single market for British-built cars after the domestic market last year according to SMMT, with exports increasing sevenfold since 2009. Although caution is necessary, recovering demand in the UK & Europe and ongoing demand in other export markets such as the US should help to ensure that the China downturn and uncertainty around its economic future is manageable.

Addressing the Skill Gap

"An ageing workforce will remain an ongoing challenge for the sector in 2016. Ensuring that the UK has a new wave of skilled workers, adept at using the latest technologies, is crucial to ensuring the UK automotive industry remains competitive.

"According to the government, predicted growth in vehicle and engine production next year will drive demand for over £3bn car components in the UK alone. In order to capitalise on this demand, both manufacturing companies and Tier 1 and Tier 2 component manufacturers must nurture engineering skills and new talent.

"This can be achieved in partnership with the government and other vested parties, through joint programmes to attract school leavers, graduates and postgraduates into the automotive industry. For example, the Lloyds Bank Advanced Manufacturing Training Centre recently opened its doors in Ansty Park, Coventry. The state of the art facility will support over 1,000 engineering and technician trainees in an attempt to provide the vital skills needed for the UK manufacturing sector and economy.

Low carbon technology

"In the wake of Volkswagen scandal, low carbon technology is increasingly under the spotlight. Emission regulations continue to tighten, with the specified drop to 95g CO2 per km in 2020 only sharpening the challenge of compliance. The EU has also said that it is committed to bringing in a new fuel economy test before 2020, which could make hitting the CO2 targets even more difficult.

"There’s still huge potential for improving catalytic combustion technology to enhance engine efficiency and reduce emissions, the problem is the cost. Many argue that if emission rules become more stringent and OEMs are forced to invest more and more in technology, diesel many no longer be a cost-effective or sustainable option, particularly for small vehicles priced at £20k or less.

"In the US, diesel currently only accounts for three percent of all vehicles in use. In Europe, it’s currently 50 per cent but this could reduce to 35 percent in the next five years and we may see a reverse in demand for petrol engines.

"On the flip side, the low carbon challenge poses a great opportunity for companies such as Toyota which are one of the market leaders in hybrid cars and currently produce very few diesel. As electric vehicles become more sophisticated and can travel further, they may also pose a more viable option.

Keeping a healthy balance sheet

"There are no clear answers to the low carbon challenge. The only certainty is the significant investment that OEMs will continue to place into R&D. The majority of OEMs typically invested circa 10 to 12 percent of their revenue into R&D in 2015. For a company like JLR, who are heavily investing in new product, it is even higher. With this in mind, retaining liquidity and a healthy balance sheet is key.

"For OEMs, particularly in the premium segment, margins are around 12 to 15 percent. Increasingly, manufacturers are recognising that to support the growth of the sector, not all the margin pressure can be placed on the supply chain.

"Key lessons have been learnt since the 2007 crash. Production and sales are now much more aligned and OEMs are no longer building cars for the sake of building cars. Companies are also now recognising the importance of implementing sustainable models to manage working capital in order to maintain profitable growth. Funding solutions and support such as supplier financing, in addition to hedging policies, can certainly help to maintain much needed liquidity.

"Despite the regulatory, political and economic challenges, the automotive sector in the UK presents an unprecedented opportunity for the UK economy and businesses, particularly as increased focus is given to localised production. The challenge is to ensure that all businesses from across the supply chain have the liquidity to capitalise on growth opportunities and to invest in R&D in order to meet low carbon technology demand.

Author: Stuart Apperley is director of automotive in the global corporates coverage team at Lloyds Bank Commercial Banking.