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Research 7 June 2017

US Economics and Credit Strategy

Technology-based change leaves retail looking overextended

x It has become accepted wisdom that the traditional retail industry is facing significant challenges from the migration of sales volume to e-commerce channels. We examine the degree to which further significant retail bankruptcies would trigger a sharp reduction in industry capacity and employment.

x We see a traditional retail industry with excess capacity. Employment has rebounded near to its prior cycle peaks amid a steady increase in physical footprint, just as technological trends seem poised to damage revenue. Capacity, as measured by store unit additions, has grown twice as fast as real sales since 2005.

x Overcapacity is not driven by exuberance and the retail sector is not a candidate for the typical bubble-bust effect on the business cycle. Yet, technology-based structural change, in our view, leaves the traditional brick and mortar retail sector looking overextended nonetheless.

x We estimate the amount of needed capacity withdrawal based on the industry's mid-cycle return on assets (ROA), or the minimum return in non-recession years prior to when e-commerce began to heavily suppress ROAs. Applying our assumptions retailer by retailer in our company universe, we think that capacity needs to be reduced by 10-13% to get ROAs back to mid-cycle values.

x We believe it is conceivable that bankruptcy proceedings at a large department store could lead to knock-off effects on other middle mall stores, regional banks, and non-retailers that lead to total job losses of around 300,000 in fairly short order. Abrupt adjustment in the retail industry could increase the severity or prolong any downturn in activity as capacity is withdrawn quickly.

x Employment in the traditional retail sector across future business cycles may behave similarly to manufacturing in recent decades, where sharp reductions in employment during recessions were followed by little to no meaningful recovery thereafter.

Michael Gapen +1 212 526 8536 michael.gapen@ BCI, US

Ryan Preclaw, CFA* +1 212 412 2249 ryan.preclaw@ BCI, US



* This author is a member of the FICC Research department who is not subject to all of the independence and disclosure standards applicable to analysts who produce retail debt research reports under US FINRA Rule 2242.

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 8

U.S. Autos & Auto Parts

Ford/GM - Driving strategies along three dimensions

CEOs of major auto companies today face the most difficult, multidimensional challenges ever seen in the industry. Yes, past CEOs had to deal with change ? but it was typically just along one dimension, occasionally two, as business cycles intruded. But now OEMs are faced with challenges along at least three dimensions. Near term, they need to manage the cycle challenges of the US SAAR plateau ? and the eventual downturn. Mid term, the challenge is to cost-effectively meet the megatrends of connected cars, Big Data, active safety, and electrified powertrains. Longer term, OEMs need to deal with #disruptivemoblity, a sharp shift from personal car ownership to purchasing transportation as a service. While we believe Ford has an edge in managing the cycle, we believe GM is ahead in the intermediate megatrends stage, and has an early lead in the longer term era of #disruptivemobility.

Near term ? managing the US SAAR cycle, advantage Ford: We believe Ford currently has an advantage given better managed inventories / better pricing dynamics. Moreover, with a smaller, and more reined-in lease book, Ford Credit holds an advantage over GM Financial, which is newer to the prime financing/leasing business. That said, GM's North America business has outperformed Ford in recent quarters. And we believe both companies can better manage through a downturn than investors give them credit ? albeit, the first couple quarters of the downturn will be rocky.

Mid term ? managing the megatrends, advantage GM: In managing the key trends of increasing electrification, active safety and connectivity/Big Data, we believe GM has the lead. It is well positioned given its experimentation with Volt and Bolt in electrification, early adoption of OnStar (providing connectivity), and its extensive use of Mobileye for autonomous braking + its upcoming highway `autopilot' launch in Super Cruise. And importantly, these experiences provide key learnings for longer-term initiatives. That said, both Ford and GM lag Tesla along most of these dimensions.

Long term ? disruptivemobility, a lead for GM, but still early days: In the much longer-term game of #disruptivemobility, both Ford and GM have been much more active than most realize, preparing for the move to autonomous vehicles and mobility as a service. Yet they have taken sharply different approaches. GM has been more aggressive in early spending on Silicon Valley firms, with its investment in Lyft and purchase of Cruise Automation. Ford, by contrast, has been later and appears to have spent less to date, preferring to focus on niches in mobility (specifically van-based ride sharing) and on acquiring talented project leads (vs. existing software) to build out Level 4/5 software. At this point, GM is in the lead vs. Ford. But as it's still early days in the race towards #disruptivemobility, it's too early to call a winner.

Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 12.

Equity Research 21 June 2017

INDUSTRY UPDATE

U.S. Autos & Auto Parts NEUTRAL Unchanged

U.S. Autos & Auto Parts Brian A. Johnson +1 212 526 5627 brian.a.johnson@ BCI, US Dan Levy, CFA +1 212 526 8047 dan.levy@ BCI, US Steven Hempel, CFA +1 312 609 7260 steven.hempel@ BCI, US

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