The fast lane: car buyers benefit from increased competition. (Special Report).

These may be the best of times for new car buyers in Mexico, with more makes and models to choose from, flexible financing and declining prices.

In a tepid economy, auto manufacturers continue to introduce new makes and models to Mexico's young and increasingly affluent families. Most notably, Japanese automotive giant Toyota founded a Mexican sales division this year and started construction on a Tijuana production plant.

But such circumstances have also made 2002 the most competitive of times for automakers, who are competing for pole position in the Mexican marketplace before key trade restrictions expire next year under Nafta.

New variety, in the form of hulking SUVs and the pint-sized MINI Cooper, has helped boost sales in a domestic market still dominated by compact cars.

Thanks to vibrant competition, prices are down. But so are profit margins, analysts suspect, and an export-dependent auto sector has been hit hard by decreased demand in the European Union, Canada and, most importantly, the United States.

During the past 12 months, manufacturers such as Ford and Volkswagen have had to cut their workforces, although without closing Mexico plants.

Dina--until recently Mexico's largest manufacturer of trucks, buses and coaches--faired worse, shuttering plants and declaring bankruptcy.

Analysts say the future strength of the automotive industry depends not only on a continuing economic recovery in the United States and Mexico but also on continued sales incentives--such as rebates and deferred-interest loans--by auto companies and greater participation by Mexico's banking industry.

Wary of a recession in the industry, automobile makers have also turned to tax relief as an answer, preparing a lobbying campaign to shake off taxes on new vehicles, luxury cars and vehicle ownership.

CONTINUED INVESTMENT

In a large vote of confidence for the industry, Toyota announced in January its re-entry into the Mexican market and broke ground in August on a new assembly plant in Tijuana. The new plant represents a US$1.5 billion investment and will cover three square kilometers when it opens in 2004 to produce carriages for the Tacoma pickup, a vehicle created under a Toyota-General Motors joint venture run by New United Motor Manufacturing.

Toyota also started this spring selling the Camry and Corolla in Mexico through Toyota Motor Sales de Mexico. The climate for such foreign investment looked somewhat hostile a year ago when an autoworkers union staged an 18-day strike at Volkswagen's Puebla plant, 105 kilometers from Mexico City. In the end, union workers received a 14.7% increase in their overall pay package.

A year later, and after large-scale job cuts at maquiladoras, expectations appear to have changed in a heavily unionized Mexican workforce.

The Volkswagen workers union, which represents more than 10,000 workers, settled within hours of a September strike deadline for a 5.5% salary increase and a 1.5% increase in benefits, well below the 10.2% salary increase originally demanded.

Despite low-wage competition from Chinese operations, Mexico's assembly plants continue to be well regarded for their efficiency. Proximity to the United States remains a plus and automobile makers still consider the country a safe harbor from the sour economic contagion that has spread across South America in 2002.

"As part of Nafta, and considering the events in Argentina and the situation in Brasil, Mexico figures as a key entity," Volkswagen North America Regional President Jens Neumann said in March, announcing financial results.

EXPECTATIONS INCREASE

Stumbling stock markets and a lukewarm world economy haven't stopped Mexico's auto industry from achieving steady sales increases in 2002.

Automakers reported sales of 557,905 vehicles during the first seven months of the year, a 10.9% increase over the same 2001 period, according to the Mexican Automotive Industry Association (AMIA).

General Motors and Nissan posted sales gains of 13.8% and 18.2% respectively in the January-through-July period. The three other major manufacturers, however, showed little change. Ford reported a 1.8% sales increase; Volkswagen, a 0.6% decrease; and DaimlerChrysler, a 3.2% decrease.

KPMG analyst Eduardo Argil credits aggressive financing for solid 2002 sales, despite faltering foreign demand.

Argil and other industry watchers say the next important step is for Mexico's banking industry to take on more auto loans and extend credit to a broader segment of Mexico's population.

Auto companies were the first to make consumer car loans after the 1994 peso crisis, and the industry's financial affiliates still hold the majority of auto loans in Mexico, where about 65% of cars are purchased on credit.

Increased bank competition may be a crucial component to maintaining growth in the domestic market.

"Everything indicates that we're starting now to see financing little by little return to where it should be, the banking industry, like it was in the past," said Argil. "The automobile is an instrument of work, it's not a luxury. If there aren't more cars it's only because people can't afford them, not because they don't need them. It's a huge market for the banks," he said.

This is not to say that the Mexican economy can't support luxury car sales.

Some luxury automobiles saw dramatic sales gains in early 2002.

Jaguar sold 768 vehicles in the first seven months of the year, a 240% gain over the same period in 2001. Land Rover more than doubled its sales. Porsche sold 187 units, 74.8% more than during the same 2001 period.

Relative newcomers Renault, which sells cars through affiliated Nissan dealerships. and Seat registered dramatic sales increases of 604% and 290% respectively, although the two companies together only account for 3.9% of the market.

Introduced to Mexico in April, BMW's MINI Cooper sold 588 units by the end of July.

Illegal, used-car imports continue to concern analysts and trouble industry leaders, who were upset in recent years by legislation that granted amnesty to the 2.5 million so-called chocolates currently circulating on Mexico's highways.

Nafta does not lift used-car restriction until 2019.

"Here the sticking point for the auto industry is that Mexico does not give amnesty again," Argil explained.

Nevertheless, the past amnesty may not have hurt the industry as much as forecasters predicted.

Old-model parts can be troublesome to find in Mexico. "El pecado lleva la penitencia. The sin carries its own penance," said Argil, relying on an old Mexican adage.

OPEN MARKETS

Already stiff, competition in the auto sector should only get more intense as Mexico prepares for the end of Nafta's protective restriction that regulated the origin of components.

By the beginning of 2004, parts and vehicles produced in Canada and the United States should enjoy the same access to the Mexican market as Mexican parts and vehicles have enjoyed for some time in the Canadian and U.S. markets.

In anticipation of this new freedom from tariffs, Mexico's auto market is attracting potential newcomers from around the world. Analysts already are heralding the potential arrival of Hyundai, Mitsubishi, Daewoo, Fiat, Citroen, Kia and other makes before the 2004 Nafta deadline.

Since the signing of Nafta, the number of automobile brands in Mexico has increased from five to 16, according to Ciemex-Wefa.

In 1993 there were only five light truck makers. Now there are 10.

Population and income demographics also explain the increasing interest in Mexico, where by 2010 about 30 million households should have the economic resources necessary to buy a new car, according to Ciemex-Wefa estimates.

Despite this burgeoning market potential, new arrivals will join an export-dependent industry humbled in 2002 by a lagging global economy.

Mexico's automakers reported exports of 676,422 vehicles in the first half of 2002, a 3.6% drop from the same period in 2001.

Exports to the United States and Canada, Mexico's most important markets, registered a 1.5% drop. During the same period, exports to Europe and South America, both relatively small markets for Mexican automobiles, dove 37.4% and 31.4% respectively.

"The external market has decreased substantially," said Berenice Yaber, an auto industry analyst at Grupo de Economistas y Asociados (GEA) of Mexico City. "Exports to the United States have remained very static and this has substantially hindered a recovery."

When the Nafta automobile restriction expires at the end of next year, automakers will confront a new panorama of competitive pressures.

"It means they'll have to optimize their levels of production to be able to compete efficiently in a market totally without protection," Yaber said. "Already they're reducing their costs of production, not so much in salaries as in fixed costs."

MARGINS DOWN

Judging from production statistics, growth in Mexico's auto industry is nearly stagnant.

Car and light truck production increased a modest 1% in the January-to-July 2002 period, compared to the same period in 2001, according to statistics from the AMIA.

DaimlerChrysler and General Motors increased production by about 59,000 during the same period.

But Ford and Volkswagen together scaled back production by more than 65,000 vehicles in the first seven months of the year, announcing layoffs in the process.

Mexico shared in the fallout when Ford in January announced 35,000 worldwide layoffs, although a round of Ford plant closings did not affect its Mexican facilities. But the fact that no new products had been chosen for Ford's plant in Cuautitlan indicated that the facility could be vulnerable if Ford has to close more plants. Further cutbacks appear to have been staved off for now by buying incentives.

Rebates, five-year loans and interest-deferral programs--all wonderful benefits for the Mexican consumer--represent a new danger for the bottom line, according to Yaber.

"It puts at risk the margins for auto assemblers that are going to have to offer more accessible prices or extra benefits to keep their market niche," Yaber said. "The consumer benefits in terms of variety and prices. But when there are more competitors, the profit margins are likely to shrink."

Car prices during the first semester of 2002 decreased 1.82%, during a period when inflation was 3.75%, according to Ciemex-Wefa.

Yaber said weak imports have hurt autopart manufacturers in particular.

"They have felt the recession much more and have registered drops in production," Yaber said.

Overall parts sales for the first half of the year declined 4.2% compared to the year before, according to the National Automotive Parts Industry (INA).

Production for the parts industry was off 2.3% in the first six months of 2002, compared to the year-ago period.

Last year major parts manufacturers Desc., Alfa., Vitro, Grupo Industrial Saltillo and Corporacion SanLuis were forced to scale back production, reacting to industry-wide sales of US$13 billion, a 3.9% decline compared to 2000.

In a flash of good news for parts makers, exports rose 5.8% in the first semester of 2002 versus the same period in 2001, narrowing Mexico's auto parts trade deficit slightly. As a major assembler of vehicles, Mexico now imports roughly twice the value of the auto parts it exports.

Heavily indebted autoparts maker SanLuis came to terms with creditors in August, announcing the restructure of US$291 million in debt, only part of the US$526 million it owes. Analysts say SanLuis does not reflect the broader economic condition of the national auto parts sector.

Auto parts are often hit first by production cutbacks at assembly plants and success depends more than ever on being able to reduce fixed costs quickly while maintaining the capacity to grow.

"If a drop in volume arrives, the industry has to be very agile, to contract and survive until another expansion arrives," said Argil of KPMG.

Corporate alliances could become more important in a weak parts market as Nafta phases out restrictions on where components originate.

The future of the national auto parts industry will depend on whether second-and third-level suppliers can align with international companies that help update manufacturing technology and quality, according to a Ciemex-Wefa analysis.

BRIGHT BUT RISKY FUTURE

The economic outlook for the auto industry continues to depend on the United States, where more than 90% of Mexico's auto exports are destined. Despite corporate accounting scandals and volatile stock markets, the U.S. economy is improving and Mexico's auto sector should see delayed improvement, said Armando Soto, who tracks the automotive industry for Ciemex-Wefa.

"Considering the United States is our principal market, the recovery won't arrive until the end of the year, and then only if the North American market continues to be stimulated by sales incentives," Soto said.

Ciemex-Wefa said under the most likely economic scenario, the auto industry will export by yearend 1.43 million vehicles, a 1.4% increase over 2001 exports. Overall production should increase 2.8%, according to the Ciemex-Wefa model.

"With the economy less favorable, with various sectors in recession, with a market in which there are more competitors and more products, the competition turns more intense and you must offer better deals," Soto said. "Let's say I give you a subsidized credit that covers 12 months or 18 months, for example. Or I give you a rebate, which is a discount in price."

Auto dealers have invested heavily in renovating brands during the past two years.

"They're not going to recover their investment rapidly," Soto said. "Some of these distributors may not be able to survive with the competition that's going to arrive with the market opening."

Soto said other key elements to future growth in the industry involve creating a vehicle registry to crack down on contraband vehicles and lowering Mexico's taxes on cars. But tax cuts are likely to meet stiff resistance from the state governments that receive direct financial benefit.

Soto said a return to sustained growth in the auto industry next year should endure through 2007, with average annual growth in exports of 9% during that five-year period.

Growth of domestic sales should be in the order of 6.2% a year, according to the Ciemex model.

These projections come with caveats, depending on the pursuit of tax decreases, greater bank participation in financing and new protections from the incursion of illegally imported used cars.

The greatest threat to growth remains the global economy and foreign investment, something mostly beyond Mexico's control.

If the world cooperates, KPMG's Argil will expect cars to become more and more accessible in coming years.

"For the consumer, now we see that what they said about the free trade agreement always was the truth--that the consumer is the winner," Argil said. "They have started winning and you're going to see more cars here."

RELATED ARTICLE: * Truck exports shift into gear

The worst may be over for Mexico's truck and bus manufacturing sector.

The industry was hit hard in 2001 by lagging exports. The 2001 total: just 11,094 vehicles exported, less than one-third the total in 1999, when 33,500 new heavy vehicles departed the country.

Truck and bus producers were running ahead of schedule at midyear, ready in August to surpass the total annual exports for 2001.

Overall sector sales from January through July were up 3.2% in 2002 from the same period in 2001.

With economic indicators suggesting an end to Mexico's 18-month economic slowdown, domestic truck and bus sales may soon enjoy a pronounced recovery, according to Mexico's National Association of Bus and Truck Producers (ANPACT), the nation's 11-member truck producers association.

If and when that recovery arrives, not every manufacturer will be there to enjoy it.

Mexican truck and bus manufacturer Dina--a founding member of ANPACT and once the nation's leading maker of bus and medium/heavy-duty trucks--closed assembly plants and declared bankruptcy this year.

The truck industry continues to contend with volatile month-to-month sales and production swings--described as "mini-cycles" in ANPACT's July market analysis.

Like the auto industry, truck makers are likely to confront a more competitive market environment, come the full liberalization of auto and truck markets in 2004 under Nafta.

Truck makers continue to argue that their business is handicapped by cheaper, illegally imported vehicles. ANPACT estimates that 30% of Mexico's working fleet is contraband.

Despite these varied concerns, consultants at Ciemex-Wefa of Mexico City project 5% growth in sales of trucks and buses by year-end, under stable interest rates and other macroeconomic conditions.

Heavy truck sales should continue to suffer, however, with a forecasted sales decline of 5.5% in 2002, Ciemex-Wefa warned.

"Even with incentives, heavy trucks can't escape this economic environment," said Armando Soto, an automotive sector analyst for Ciemex-Wefa. "These vehicles are more involved in industry. So if you have an economic situation like the one right now--still weak--it's reflected in capital goods and transportation improvements."

By the end of July, the truck sector still was trailing behind these growth projections, thanks to poor domestic sales.

Domestic sales of trucks and buses registered a 20% decline during the first seven months of 2002, compared to the previous year.

Recent production figures suggest the truck industry is gearing up for its own comeback, producing 4,509 vehicles in July, the biggest production month in at least 19 months, according to ANPACT.

Between January and July, the industry produced 24,900 vehicles, an 1l.5% gain over the same period in 2001. Prices for trucks and buses held steady or gained against inflation figures.

Even these bullish figures contain mixed news--or "mini-cycles," in ANPACT'S words.

Tractor-trailer production increased 86.4% in January through July terms, while bus production dropped 49%.

The revival of exports is perhaps the most noteworthy trend so far this year--they're up 73% sector-wide.

In the words of ANPACT's monthly editorial:"Pretty good don't you think?"

Morgan Lee is a Mexico-City based freelance writer and a correspondent for the Albuquerque Journal.