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Morningstar | We Think Trump's Mexican Tariffs Are Horrible for the U.S. Auto Industry

On May 30, President Donald Trump announced that on June 10 he will respond to immigration problems at the U.S. Mexican border by using the 1977 International Emergency Economic Powers Act to impose a 5% tariff on all goods imported from Mexico. This tariff will rise to 10% on July 1 and reach a maximum of 25% on Oct. 1 if Mexico does not take adequate, but unspecified, measures to stop illegal immigrants to the U.S. For now, we are leaving our U.S. autos coverage fair value estimates in place because we think this tariff is horrible for the U.S. auto industry and Trump will have major pushback from even Republican lawmakers. We think the move also jeopardizes congressional ratification of the Trump-led United States-Mexico-Canada Agreement to replace NAFTA because why vote for it if there will be a 25% tariff on Mexican goods? We stress the outcome of this new tariff battle is highly uncertain and could be resolved quickly if Mexico takes steps on border control to satisfy Trump. In the unlikely event a 25% tariff remained in place for a long time, we'd probably reduce our GM and Ford fair value estimates for tariff overhang--an increase in our cost of equity uncertainty on each name would reduce GM into the high-$30s and Ford to about $10. We likely would not change midcycle operating margin assumptions because we doubt the tariffs would last beyond Trump's administration.

We dislike the tariffs because even vehicles made in the U.S., such as Ford's F-Series pickups or GM's fullsize SUVs, have Mexican parts content, 15% for the F-150 and 44% for the SUVs. The Center for Automotive Research estimates parts can cross NAFTA borders up to eight times during vehicle assembly, so the tariff costs would be large. We expect automakers will pass along 5% tariffs to consumers, but we think that becomes hard to do at levels above that point because tariff exposure is not equal across firms. U.S. automakers cannot quickly change production, so they would suffer greatly.

We calculate that for 2019 through April, GM had 27.7% of all its North American production in Mexico and Ford had 11.1%. Toyota and Honda, for perspective, use Canada more than Mexico, so their Mexican production mixes were 9.5% and 11.7%, respectively. Pickups are the most critical tariff risk because they are the most profitable vehicles automakers produce, and the Detroit Three dominated the fullsize pickup segment with 93% U.S. share last year. GM said on page 28 of its 10-K that trucks have a variable profit of 180% of GM North America's portfolio on a weighted average basis. Page 30 of Ford's 10-K says, "in North America, our larger, more profitable vehicles had an average contribution margin that was about 140% of our total average contribution margin across all vehicles." Ford makes all its pickups in the U.S. but as mentioned earlier does have Mexican parts content in the trucks. Still, we expect its tariff exposure to be less than GM's due to less tariff exposure. Ford still makes the Fiesta and Fusion sedans in Mexico, but these vehicles are scheduled to be discontinued as soon as this year in Fiesta's case. The Lincoln MKZ sedan is made in Mexico.

We calculate GM makes about 39% of the Chevrolet Silverado and GMC Sierra fullsize pickups in Mexico, and this production includes all Sierra crew cab and some Silverado Crew Cabs, a trim that GM is prioritizing with the new generation truck since last year because GM lags Ford in crew cab mix. Having to stop production or move production would be very expensive and time consuming. GM also makes the Blazer crossover in Mexico, nearly half of Equinox crossovers in Mexico, and all GMC Terrain crossovers in Mexico. We estimate that if GM does not pass the tariff onto consumers, the Mexican-made pickups and crossovers with a 5% tariff would cost GM $440 million in annual pretax profit and that a 25% tariff would cost it $2.2 billion. In reality, these figures could prove low because they are only for Mexican-made vehicles and ignore tariffs on Mexican parts going into U.S.-made vehicles. GM does not disclose enough information for us to estimate a companywide impact, so we focus on the Mexican production because it involves profitable light truck models.

The other ramification of Trump's tariff policy is that he is using tariffs to impact immigration policy rather than economic policy. We suspect there will be many legal challenges by U.S. companies and the Mexican government to these tariffs, but resolving these disputes in court will take time. Trade policies matter drastically here, too, because the 25% tariffs from immigration conflict with NAFTA. If those 25% tariffs happen in October and if USMCA is not ratified and Trump withdraws from NAFTA, the so called "chicken tax" on pickups imported into the U.S. goes into effect. The chicken tax is a 25% tariff, so GM Mexican-made pickups would have a 50% tariff on them to be sold into GM's home country. We hope Trump never reaches that point, but if he does, GM would in our view have no choice but to move all pickup production to the U.S., which would cost billions in tooling plants and impairments. For more of our thoughts on USMCA and the chicken tax, see our Jan. 7 report, "The U.S. Auto Industry Should Want USMCA to be Ratified."