Citi and INCR Report: Tougher CAFE Standards May Be Profitable for Auto Industry and Shareholders

A new analysis by Citi and the Investor Network on Climate Risk finds that the Senate proposal to raise fuel economy standards for U.S. cars and trucks will have only a minor impact on shareholders of auto companies.

The report's results found that increasing corporate average fuel economy (CAFE) standards by 2012 could actually benefit General Motors, while foreign automakers profits are largely unaffected.

"Our analysis reveals that the 2020 target is tough but attainable, requiring aggregate improvements of 2.5 percent a year, and--surprisingly--generating some growth in variable profits for most automakers," wrote Citi.

The report, "CAFE and the U.S. Auto Industry: A Growing Auto Investor Issue, 2012-2020," will be the focus of a Wall Street briefing today in New York for investors.

A partnership between Citi Investment Research and the Investor Network on Climate Risk (INCR), along with industry experts at the Planning Edge, University of Michigan Transportation Research Institute, and NRDC, evaluated the investment implications of potential changes to the U.S. CAFE program.

The analysis comes as Congress is considering new legislation that would raise fuel economy standards for passenger vehicles to 35 miles per gallon by 2020, about 40 percent or 10 mpg above today's levels. The CAFE standard has not been significantly raised since Congress originally adopted it 32 years ago when Congress sought to lessen U.S. dependence on oil from volatile Middle-Eastern countries.

In order to assess how Wall Street should react to such an increase in fuel economy, Citi's Equity and Debt Research department teamed up with the Investor Network on Climate Risk--which represents over $4 trillion in institutional investors--to conduct a forward-looking simulation of the earnings impacts over the next five-year investment horizon. The report is a follow-up to a similar study released in January by Citi's Equity Research division that examined the European Union's proposed new CO2 reduction rules for vehicles in Europe.

The U.S. analysis employed a complex, proprietary modeling program that combined supply-and demand-side simulations with Citi's financial models. Detroit veterans and industry experts, the Planning Edge and the University of Michigan Transportation Research Institute, led the team's analysis.

The report concludes that tougher CAFE standards, which it predicts will come into effect before 2012, can be met "with modest additions of existing technologies" and will likely be "most beneficial to General Motors and least beneficial to Chrysler."

The real winners will be the technology manufacturers, and investors should focus on buying suppliers with leverage to fuel savings technology.

Among the report's other key findings:

• Using the best available information, higher CAFE appears to be neutral to 2012 earnings.
• Automakers are expected to partly rely on shifting sales mix to more fuel-efficient models to meet tougher CAFE standards, but the most profit-maximizing approach appears to be through investments in fuel-savings technologies--higher efficiency internal combustion engines, in particular--applied to cars and trucks alike.
• Most automakers earnings will be largely unaffected by the CAFE standards in the 2012 time horizon, but some companies, like GM, could gain as much as $0.25 per share in earnings.
• Suppliers of key technologies such as turbochargers, automated manual transmissions and diesel engine fuel injectors stand to gain $4.3 billion in growth by 2012 and even more by 2020

"The report's findings are encouraging because it shows that automakers' shareholders can thrive while the automakers build cars and trucks that are better for our health and reduce global warming pollution," said Mindy S. Lubber, president of Ceres and director of the Investor Network on Climate Risk, comprised of 60 institutional investors managing more than $4 trillion in assets. "Automakers have an opportunity today to both advance fuel efficiency technology and become more globally competitive and sustainable in the process."

About Ceres and INCR

Ceres is a leading coalition of investors, environmental groups and other public interest organizations working with companies to address sustainability challenges such as global climate change. Ceres also directs the Investor Network on Climate Risk, a network of 60 institutional investors managing $4 trillion in assets focused on the business impacts of climate change. For more information, visit www.ceres.org