© Amy Walters / Fotolia

Moscow/Munich, September 2014

Russian automotive market update: what would be the real cost of sanctions?

2

Management summary > With 12% decline in the first eight months of 2014, Russia is in the middle of our pessimistic market

scenario, which we developed in May 2014 – Quick return to growth path is not expected > Potential sanctions against the automotive industry create additional pressure and uncertainty > Roland Berger analyzed three scenarios for potential sanctions, ranging from an increase in duties for

vehicle imports from EU/US to a full import embargo on vehicles from EU/US > Conclusions of this analysis:

– Market volume would decline in each scenario due to higher prices and lower variety of vehicles – An import duty increase is the only sanction that is advantageous for Russia – though the overall

impact is limited – Import embargos on EU/US vehicles – for part of the fleet or in full – damage the Russian state 3x

more than affected OEMs and result in up to EUR 1.4 bn lower state budget income – The only winners of such import embargos would be Asian OEMs – Impact on Russian OEMs limited

> Instead of sanctions, we recommend the Russian state should rather address two main issues: – Long-term stable and attractively high market volume – Cost-competitive local vehicle production

> Nonetheless, the potentially affected OEMs should consider sanctions as a possible scenario in their strategic plans and be prepared with proper mitigation strategies

3

Change vs. Jan-Aug 2013

The Russian automotive market continues to be in crisis mode, further decline expected Light vehicle1) sales development in Russia, 2008-2014

1.9

2010 2012 2014F

2.4

2013

2.8 2.9

2009 2011

2.7

1.5

2008

3.0

1.6

0.8 1.0

1.8

Source: AEB, Autostat

Sales 2008-2014 [m cars] Sales Jun-Aug 2014 ['000 cars]

1) Light vehicles include passenger vehicles and light commercial vehicles

-6% -12% -17% -23% -2% 0% -8% -26%

172

Jul

201

May Feb Jan

153

199 206

Jun Aug

227

Apr Mar

181

243

-12%

-20%

January- August

September- December

4

Almost every OEM in Russia is facing dropping sales volumes

Premium Volume EU/US Volume Asian Russian

103 247 42 46 31 29 26 32 43 40 123 23 85 56 103 24 124 82

Sales of major brands in Russia, Jan-Aug 2014 vs. Jan-Aug 2013 [%]

Source: AEB

16%

-20% -18% -20% -20%

15%

-7%

1%

18%

-5%

-43%

-19%

-2%

-27%

-18%

-10%

-3% -5%

Jan-Aug 2014 vs. Jan-Aug 2013 XX Sales in Jan-Aug 2014 ['000 vehicles]

5

Russia is on the path of our pessimistic scenario – Quick return to growth track is not expected Roland Berger sales scenarios, 2012-2020 [m units]

Source: IHS; Roland Berger estimates and analysis

> Until recently, positive development of automotive market in Russia expected

> Sales forecasts exceeded 4 m vehicles by 2020

> In May 2014, Roland Berger published a study "Russia at the crossroads" and developed updated market scenarios, taking into account: – Weakening macroeconomics – Implications of Russia's WTO

accession – Emerging Crimea crisis

> Since then, the situation has worsened > Russia is currently following our

pessimistic case > Quick return to growth track is not

foreseeable

1) Light vehicles include passenger vehicles and light commercial vehicles

2012 2013 2014 2015 2016 2017 2018 2019 2020

1.5

1.2

3.6

2.4

3.3

3.0

2.7

2.1

1.8

2.5

2.9

2.8

2.2

2.7

2.5

2.4 2.5

3.2

2.8

3.4

3.1

2.7

2.8 2.8

3.6

2.8

2.8 2.9

3.2

3.0

2.6

3.1

2.9 2.5

Light vehicle sales1) [m units]

Optimistic case Pessimistic case

Base case

FORECAST FORECAST

6

The ongoing conflict and exchange of sanctions between EU/US and Russia put additional pressure on the automotive market Key events of Russia-Ukraine crisis and resulting sanctions

Referendum, held in Crimea in March 2014, resulted in the accession of Crimea to Russia in April 2014

Start of military conflict in Donetsk and Lugansk regions of Ukraine

Boeing 777 passenger plane shot down. Further escalation of the situation in Eastern Ukraine

1st ROUND OF SANCTIONS > Sanctions against Russian

individuals (first Russian and Crimean officials) by the EU and US

> Sanctions against Russian entities (banks owned or controlled by government) by the US

2nd ROUND OF SANCTIONS > Sanctions against Russian

individuals (state officials, businessmen incl. Rotenberg, Timchenko) by the US and EU

> Sanctions against companies (largest banks, oil, defense companies) by the US

3rd ROUND OF SANCTIONS > Sanctions against Russian

companies (oil, infrastructure and defense, dual-use technology, Crimean companies, banks incl. Bank Moskvy, VTB, Rosselkhozbank) by the US and EU

> Extension of the list of banned individuals by the EU

March August May September

Claims of presence of Russian troops in Ukraine. No significant de-escalation despite truce. Gazprom's gas threats

> Sanctions against selected US and EU citizens (lists are not disclosed) at the end of March

> Restrictions on the operations of global payment systems in Russia

> Extension of the list of people who are banned from entering Russian territory

> Embargo on selected agricultural products from the countries that imposed sanctions on Russia

RETALIATION BY THE RUSSIAN FEDERATION ? ES

CALA

TION

OF

CONF

LICT

- ?

Source: EUR-Lex, US Department of Treasury, press

4th ROUND OF SANCTIONS (from September, 12) > Restriction of access to the capital markets for oil &

gas companies (Gazprom, Rosneft, Transneft) and defense firms (UAC, UVZ, Oboronprom)

> Tightening of access to long-term funding for Russia's largest banks

> Broadening the ban on sales of dual-use technologies

> Asset freezes and ban on visa issuing for Russian officials

7

> Restrictions on imports of industrial goods (especially cars, ships, aircraft)

> Prohibition of transit flights and flights within Russian airspace

> Embargo on household chemical goods imports

> Embargo on fashion and textile products imports

Sanctions directly against the automotive industry are potentially the next countermeasures in response to new sanctions from the EU/US

"

We are potentially ready to introduce protective measures in aircraft, shipbuilding, automotive and other industries

Dmitry Medvedev, Russian Prime Minister

" "

" It is not inconceivable that in the nearest future the government will consider measures restricting the import of light vehicles costing less than 800,000 rubles (~EUR 17 k)

Vladimir Gutenev, 1st deputy chairman of State Duma

industrial committee

"

One of the potential sanctions is the complete or almost complete restriction of car imports from unfriendly states

Federal official "

Selected quotes of Russian officials

" "

There are a number of consumer goods where our European partners are more dependent on Russia… for example, car imports…

Andrei Belousov, Russian Presidential Aide

Possible areas of future sanction policy

Source: Press

8

We analyzed three basic scenarios for possible sanctions against vehicle imports from Western countries (EU/US)

High

ECON

OMIC

IMPA

CT

Low

Basic scenarios – further evaluated > Damage to Western producers/governments > Stimulation of domestic production > These or similar measures are therefore possible

Extreme scenarios – not considered further > Significant negative impact on domestic

automotive industry > Likely to be avoided by the Russian

government

Increase of CBU import duties (+10%) 2)

Embargo on CBU imports (<EUR 30 k) 3)4)

Embargo on all CBU imports3)

Subsidies elimination

Import embargo on components

Scenario 1

Scenario 2

Scenario 3

Scenario 4

Scenario 5

"… if sanctions are taken, then only to provide better conditions for ourselves"

Vladimir Putin Russian President

1) Sanctions only evaluated for light vehicles. Similar sanctions may be introduced for commercial vehicles, additional further sanctions with minor impact possible 2) Assumption: 10 percentage point increase for CBU imports from EU/US 3) Imports from EU/US 4) 30 k – retail price in EUR, including VAT

Overview of potential scenarios relating to sanctions in the automotive industry1)

9

The case study of Iran suggests that production-related sanctions are likely to be avoided

SANCTIONS

Prohibition of the sale, supply or transfer to Iran of goods or services relating to the automotive industry supported by the EU (since March 24, 2012), US, Japan and South Korea (since July 1, 2013)

794

-52%

2013 2011

1,649

COST INCREASE > Due to restricted supply from South Korea (supplied >60% of all components),

OEMs' production costs increased by 40%

PRODUCTION DECLINE > Foreign OEMs (PSA, Renault,

Fiat, GM, Hyundai, Toyota) decided to adjust capacity/ production volumes due to cost increase and lack of specific components

> 20% of 860 component suppliers in Iran halted production

DEMAND DECLINE > The market dropped by 35-40% due to the price increase and limited supply

Production of LV in Iran ['000 vehicles]

Source: US Department of Treasury, OICA, press

Example: Impact of sanctions on the Iranian automotive industry

10

Key assumptions for assessing the impact on the market, OEM profits as well as the Russian economy developed Overview of key assumptions

1) For calculation purposes split into two price categories: <EUR 15 k and EUR 15-30 k

Reduction of EU/US imports

…of which replaced…

Additional assumptions

> Profit contribution per vehicle: – < EUR 30 k:

EUR 1,000-2,000 – > EUR 30 k:

EUR 5,000 > Avg. vehicle price:

– < EUR 30 k: EUR 12,500-22,500

– > EUR 30 k: EUR 50,000

> VAT 18% > Scrappage fee:

EUR 500 per vehicle

Split of replacements: EU/ US brands

Asian brands

Russian brands

Scenario 1: Increase of import duties

<301) 40-80% 80-100% 50-70% 10-40% 0-10%

>30 10% 20% 50% 50% 0%

Scenario 2: Embargo on CBU imports (<EUR 30 k)

<301) 100% 60-80% 50-70% 10-60% 0-10%

>30 0%

Scenario 3: Embargo on all CBU imports

<301) 100% 60-80% 50-70% 10-60% 0-10%

>30 100% 40% 50% 50% 0%

Retail price [EUR '000]

Retail price [EUR '000]

Retail price [EUR '000]

Source: Expert interviews

11

Significantly lower variety of supply

Delayed purchases, especially in > EUR 30 k segment

Repl

acem

ent b

y In the event of a full import embargo, there is a risk that there will be no substitution for up to 50% of affected vehicles Overview of sanction effects on the market [m units]

Scenario 1: Increase of import duties

Scenario 2: Embargo on CBU imports (< EUR 30 k)

Scenario 3: Embargo on all CBU imports

Price increase and shift in market shares

Majority of affected volume substituted

Lower variety of supply Delayed purchases and

partial switch to Asian brands

30

70

230

Total market after sanctions 2,226

Asian brands 25

Total market, 2015 (pessimistic case)

Russian brands 1

Import reductions from EU/US

2,240

Local EU/US production

40

40

230

1

2,186

135

2,240

60

60

2,240

1

230

230

2,131 109 k 54 k 14 k

Affected volume Affected volume Affected volume

12

-250-200-150

-100-50

050

100150200

600 400 200 0 -200 -400 -600 -800

Russian brands EU/US brands

Asian brands

-200

-150

-100

-50

0

50

100

150

200

600 400 200 0 -200 -400 -600 -800

Change in global profits [EUR m]

Asian brands

Russian brands

EU/US brands -250-200-150

-100-50

050

100150200

600 400 200 0 -200 -400 -600 -800

Asian brands

Russian brands

EU/US brands

EU/US OEMs could lose about EUR 550 m, while Asian OEMs emerge as key winners; limited impact on Russian brands Impact on OEM groups – Sales in Russia and global profits Scenario 1: Increase of import duties

Scenario 2: Embargo on CBU imports (< EUR 30 k)

Scenario 3: Embargo on all CBU imports

Change in sales ['000 units]

No impact Only

winner

Loss of EUR 550 m

Only winner

13

The biggest loser would be the Russian state: up to EUR 1.4 bn lower budget income under full embargo scenario Impact on Russian budget income [EUR m]

Positive, but very low impact

-160

-90

Total +55

Employment tax +10

Profit tax +15

Scrappage fee -20

Import duty, higher rate effect +300

Import duty, volume effect

VAT

-50

-170

-465

-280

+15

+20

0

-130

-750

-600

+20

-1,420

+40

0

Significant loss in tax/duties income Only limited positive impact from higher local production

Scenario 1: Increase of import duties

Scenario 2: Embargo on CBU imports (< EUR 30 k)

Scenario 3: Embargo on all CBU imports

14

Key take-away: Import embargos are harmful to all sides and should not be introduced Summary of impacts and conclusions [EUR m]

Scenario 1: Increase of import duties

Scenario 2: Embargo on CBU imports (< EUR 30 k)

Scenario 3: Embargo on all CBU imports

Budget impact for Russia Profit loss for EU/US OEMs

+55

-100 -175

-465

-550

-1,420

Conclusions

> Limited impact of an increase in duties for EU/US OEMs only – most likely not worth the effort > Greater short-term and long-term self-damage to Russia though import embargos:

– Short-term: budget revenue shortages higher than "punishment" effect – Long-term: strengthening of Chinese/Asian brands as direct competitors to Russian brands

15

Instead, the Russian state should address two main issues – Long-term market stimulation and cost-competitive domestic production Possible measures to support the Russian automotive industry Measures by the state Current status Further steps

Long-term market stimulation

Cost-competitive domestic production

> New program introduced in September, including recycling and trade-in compensa-tion (limited impact expected overall)

> Age limitation of vehicles in use under consideration

> Implementation of age limitation measures > Streamlining of vehicle check-up process

to increase quality on the road > In addition: improvement of road

infrastructure

Lifecycle regulation/ other

> Loan rate subsidy program stopped in 2013 > Introduction of sales support mechanisms (especially in rural regions)

> Simplification of legal framework for private car leasing/sharing

Sales support

> Review of import duties for select articles under consideration

> Long-term increase of import duties on CBUs (for all OEMs)

> Support for localization of key raw materials (e.g. automotive-grade steel)

> Introduction of a special agency for component clusters development

> Reduction in import duties for sub-components

Support for localization

> Provision of state guarantees to Kamaz

> Subsidy of loan rate for AvtoVAZ's modernization projects

> Provision of subsidies for exports > Controlled ruble devaluation Financing/

hedging

16

In any case, we recommend that EU/US OEMs should adjust their risk profile and prepare for possible sanctions Recommendations for EU/US OEMs

Our recommendations What to expect?

Adjust local cost base to new market scenarios

Keep production in Russia and increase local content (at low investments)

Maintain relations with Russian counterparts/authorities

Investigate supply alternatives for imported goods (e.g. from Asia)

Examine opportunities for support programs

Market recovery is not expected in the near future, rather a further decline is anticipated

Crisis likely to last another 1-1.5 years, further escalation is possible

Automotive sanctions – even if not economically reasonable – are possible

17

Recommended further readings

Impact of economic sanctions

BRIC study for suppliers

Russia at the crossroads

> Derivation of three market development scenarios

> Assessment of regulations and cost competitiveness of local production

> Implications and action need for key stakeholders

> Overview of economic sanctions related to Russia

> Scenarios for further crisis development

> Impact on Germany and selected industries

> Assessment of market and business environment in BRIC

> Implications for supplier growth strategies and funding allocation

© Amy Walters / Fotolia