CBO: Auto Tariffs under USMCA Could Hit $3 Billion

The United States-Mexico-Canada Agreement (or USMCA) was signed by the three parties last week. It is an update to its predecessor, the North American Free Trade Agreement (or NAFTA). While USMCA touches on various trade issues, our focus in this article remains on the auto tariffs under USMCA.

The Congressional Budget Office (or CBO) estimates that automakers could be liable for $3 billion in tariffs over the next decade due to the specifications in USMCA. Mexico has already ratified the agreement, and the US House of Representatives may take it up today. Canada could be the last country to ratify it.

How tariffs affect automakers

Under USMCA, automakers would have to source 75% of content regionally to avoid tariffs. Under NAFTA, this requirement was 62.5%. Regional content refers to parts and raw material produced in the three countries signing the agreement.

In addition, 40%–65% of the content should be procured from areas where wages are at least $16 per hour. That means all that content must be taken from either the US or Canada. Merely procuring over 75% of the content from Mexico won’t let automakers escape these tariffs. If automakers fail to do so, they would be liable for tariffs in the importing country.

Autos and USMCA: The good and the bad

On the brighter side, the provisions under the USMCA to procure 40%–65% of the content from the US and Canada might help auto part suppliers. Magna International (MGA), a Canadian auto supplier, could be a good bet. Wall Street analysts are moderately bullish on the stock, with seven of 18 analysts recommending a “buy” and nine recommending a “hold.”

The average target price over the next 12 months points to an 8.7% upside over yesterday’s close. Magna International supplies parts to all major OEM automakers, including General Motors, Ford, and Fiat Chrysler.

The USMCA may not help President Trump bring automobile factories back to the US. Automakers may simply substitute parts and components from the US and Canada, bring them to Mexico, and assemble cars there. Direct labor still accounts for 21% of the total cost of producing a car, which is cheaper in Mexico.

USMCA: The ugly

Materials account for almost half of the cost of producing a car. Procuring 40%–65% of the materials from higher-wage areas would also increase material costs. So, USMCA provisions may increase the cost of producing a car.

USMCA also mandates procuring 70% of the steel and aluminum regionally. Steel and aluminum together account for 30% of the cost of production of a car, directly or indirectly. Expensive steel also means more expensive cars. If automakers don’t comply with regional content requirements, the tariffs would make the cars more expensive. In short, we expect car prices to increase in any case due to USMCA.

For the auto industry, this could add insult to injury. In the first 11 months of 2019, General Motors (GM) has seen a 2.1% drop in US deliveries while Ford (F) and Fiat’s (FCAU) US deliveries have dropped by 3.3% and 1.3%, respectively.

Elsewhere, US automakers are also lagging. American brands, which accounted for 7.4% of the market share in China, were the lowest performers in November with a decline over 28%. In the first 11 months of 2019, American brands saw over a 23% decline in sales in China.

The USMCA provisions may make life harder for American carmakers by making vehicles more expensive in their home market. However, one company may be an exception.

Tesla is cruising ahead

While other automakers are struggling, electric carmaker Tesla is surging. Tesla (TSLA) stock closed at a record high yesterday and was up 1.7% at 9:50 AM ET. Tesla has seen a 46% increase in deliveries in the US during the first 11 months of 2019.

According to analysts, Tesla is ahead of its competition in key areas in electric vehicle development. While discussing Tesla’s competitive advantage, Credit Suisse’s Dan Levy said, “We believe Tesla is leading in the areas that will likely define the future of carmaking – software and electrification.”

Even long-time Tesla bears like CNBC’s Jim Cramer are getting excited about Tesla stock. This week, Cramer said, “I don’t want you to own Ford, I want you to own the stock of Tesla.”

Oppenheimer analyst Colin Rusch also had good things to say about Tesla. In a note, he said that “expectations for a relatively smooth (production) ramp of Tesla’s China facility are increasing.” With auto tariffs under USMCA hitting them hard at home, will Detroit automakers manage to challenge Tesla? Stay tuned as we follow these developments.