Long U.S Autos Vs. Short European: Part 1

by: Bidness Etc

The European auto industry is passing through a nightmare, as rising unemployment and the sovereign debt crisis have adversely impacted European auto sales. Moreover, emerging markets have not generated enough demand, as was expected. Margins have plummeted and car manufacturers are fighting with the government and labor unions to restructure their units in order to address overcapacity. Peugeot (OTCPK:PEUGF) and General Motors (NYSE:GM) are expected to close their plants at Aulney and Bochum by 2014.

On the other hand, U.S. Seasonally Adjusted Annualized Selling Rate (SAAR) is soaring above 14.1 million, as customers rush to buy new cars with the cheap and easy available credit and cheap fuel prices. Margins for these firms are also improving, as inventories are not so high, and the rise in demand is met by a rise in prices of vehicles.

Since it will take some time for the European economy to recover, which is the most important factor on which European auto sales rely, the investment thesis proposed is to long U.S. car stocks and short European car stocks.

The full-fledged analysis will be covered in two reports. The first part, which is given below, will compare the U.S. auto industry with the European auto industry on a macro level, and briefly touch upon the factors that can help decide the stocks that can be shorted and the ones that can be recommended as buys in order to benefit from the rising U.S. auto industry and the falling European auto industry.

Seasonally Adjusted Annualized Selling Rate

SAARTOTL shows us the total sales of cars and light trucks in the U.S. As stated above, the SAAR for Western Europe (WE) is declining. However, the SAAR for the U.S. is rising. The graph given below shows the comparison:

Click to enlarge.

The graph shows the YoY change in SAAR's value. The table shows that SAAR has been on a decline for the past few years in the WE.

Italian, Spanish and French car makers are experiencing one of the worst sales seasons of their lives. The following table shows their collapse in demands and the comparison to positive growth in the U.S.:

The graph shows that Italy, France and Spain have been hit by the crisis. This is primarily because of the local car manufacturers in these countries.

Italy is thriving through a slow household economy. Spain's situation can be understood by the fact that the country recently filed for assistance, as the 10-year bond yield rose immensely in a short span of time. The French community is also depending on the new socialist government of Francois Hollande to increase government spending which can trigger growth in the stagnant economy.

Germany has been able to show positive growth in these circumstances, though it is much less than what was expected. This is primarily because of Germany having a healthy economy, as it is the hub of industrial production and technological innovations in Europe. The following chart shows the holistic view of how auto sales have been disturbed in WE.


To add to the woes of decreasing sales, car margins have been brought down considerably to attract new demand. The margins for Fiat (FIATY.PK) fell from 18% to 16%. The margins for Ford (NYSE:F) fell from 15% to 13%. Along with low demand, competition given by cheap Asian car models have also eroded the industry's profits in Europe. However, luxury cars have retained their margins and companies like Daimler (OTCPK:DDAIF), BMW and Volkswagen (OTCPK:VLKAF) have relied on these cars to maintain their profitability.

When gauging which stocks will be hit the most by the falling auto sales, we should analyze which firms export their vehicles outside Europe and which do not. It is the end markets of the auto manufacturers that will determine the sales volumes. In this context, it is relevant to say that emerging markets are not growing at a pace that was expected earlier this year. Chinese sales are shown in the following chart:

The growth, as shown below, has been disappointing for the last two years, and it is expected to remain subdued in the next year as well.

Growth in Brazil has also been slow because of the tight monetary policy that was implemented to achieve inflation and growth balance. The sales of light vehicles were down 10% YoY this April.

Similarly, firms that rely heavily on French, Spanish or Italian markets for their revenues will have a tough time for the next year and a half.

The following graph shows the future Compound Annual Growth Rate (CAGR) from 2011 to 2014, for the troubled economies, compared with the U.S.:

The chart shows the areas from which the four firms are getting their revenues. FIAT having almost 35%-40% coming from the troubled European nations proves why the company had to close its plant in Sicily. Renault and Peugeot are also heavily reliant on WE for their revenues. However, Daimler gets its revenues from all around the world and its revenue from Germany is also "safe in future" given the economic strength there.

Inventory plays an important role when it comes to pricing, as price is determined by the forces of demand and supply. European manufacturers have been hit hard due to large inventories, as this has not only reduced their margins, but also forced them to carry out downsizing and pay fines and penalties to strong labor unions in Europe. The following shows the inventory levels for three of the car manufacturers:

The inventory day's supply for Peugeot (PSA) and Renault, as compared to Ford, shows that they both are carrying larger inventories.

Currently, 30 of the 98 car assembly plants owned by major car manufacturers are running on less than 70% utilization rates. The following shows the utilization rates of some of the car manufacturers in Europe:

According to LMC automotive, WE will suffer from a 6% decline in revenues in the next 12 months. Also, the sale's growth is expected to remain flat in 2013.

Following events can have an influence on the auto industry:

  • Upcoming elections in Greece and the country's strategy on exiting the EU.
  • Any scrappage scheme that is introduced in Europe to generate new sales for the auto market. Firms like Renault have been pressing upon the reintroduction of these schemes.
  • Future forecasts of GDP for European nations. The following chart shows the most recent forecasts:

In part 2 we will present our buy and sell recommendations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.