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October 09, 2013 - Automotive Stock Outlook - by Zacks Investment Research
The automobile sector has performed impressively this year, buoyed by economic recovery and escalating demand in the U.S. and Asia. Auto sales soared to a remarkable high, driving the automobile stocks higher.
In the first nine months of 2013, General Motors Company (NYSE:GM) was the leading automaker with an 18.0% market share in the U.S., followed by Ford Motor Co. (NYSE:F) with a 16.0% market share. Toyota Motor Corp. (TM - Analyst Report) had a 14.4% market share, Chrysler had 11.5%, and Honda Motor Co. Ltd. (NYSE:HMC), Hyundai-Kia and Nissan Motor Co. Ltd. (OTCPK:NSANY) occupied the last spots in the above-5% bracket with 9.8%, 8.2% and 8.0% market shares, respectively.
General Motors regained its top sales position from Toyota, which led the market in 2012 with 9.75 million vehicles sold globally, exceeding General Motors' 9.29 million vehicles. Germany's Volkswagen AG (OTCPK:VLKAY) came third with 9.07 million vehicles sold in the year.
Zacks Industry Rank - Positive Outlook
The distinctive attributes of the auto industry impelled us to have a dedicated sector for the industry in our database. The automobile sector is one of the 16 Zacks sectors, unlike the S&P classification where autos are clubbed into the Consumer Discretionary sector (the S&P has 10 sectors vs. 16 for Zacks).
At the expanded classification level, the Zacks auto sector is divided into five industries: Auto-Domestic, Auto-Foreign, Auto/Truck-Original, Auto/Truck-Replacement and Engines. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry. The sector's retail operations are part of the Zacks Retail sector in two industries -- one for Automobile/Trucks and the other for Auto Parts.
The current Zacks Industry Rank for Auto-Domestic is #48, Auto-Foreign is #15, Auto/Truck-Original is #28, Auto/Truck-Replacement is #37, Engines is #15, Retail/Wholesale Auto/Truck is #30 and Retail/Wholesale-Auto Parts is #77. As a reference point, the outlook for industries with Zacks Industry Rank of #88 and lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'
This implies that the general outlook for all auto-related industries is positive. We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.
Sector Level Earnings Trend
The auto sector is expected to contribute 1.9% of total S&P 500 earnings in 2013, more than its 1.6% market cap weightage in the index at present.
The second-quarter 2013 results for the sector were impressive in terms of both beat ratios (percentage of companies coming out with positive surprises) and earnings growth. The earnings beat ratio was an astounding 100%, while the revenue beat ratio was 70%.
Total earnings for this sector rose 14.1% in the second quarter of 2013, bouncing back from a year-over-year decline of 20.6% in the first quarter. The sector witnessed a 4.8% increase in revenues in the second quarter, while revenues remained in line with the year-ago quarter in the first quarter of 2013.
Looking at the Consensus earnings expectations for the rest of the year, earnings for the auto sector are expected to decline 1.8% in the third quarter of 2013, placing it among the laggards in the sectors covered by Zacks.
However, the downturn in the third quarter is expected to be offset by a 25.8% surge in earnings in the fourth quarter, thereby making it one of the best performing sectors. Even the full-year earnings growth of the auto sector is expected to be around 9%, placing it among the expected winners in 2013.
On the revenue front, things are expected to be less volatile, with a 5.2% and 3.4% increase expected in the third and fourth quarters, respectively. The revenue growth in 2013 is also expected to be a modest 2.9%.
Concentration of the market share in the hands of a few companies makes the automobile sector highly competitive. The top 10 global automakers account for nearly 94% of the total vehicles sold in the U.S. To remain competitive, automakers will need to design technologically advanced and economic vehicles that will cater to consumers in both mature and emerging markets.
Toward this goal, Ford has undertaken the "One Manufacturing" strategy, which aims at producing multiple models in worldwide plants in order to reduce production expenditure and adapt swiftly to changing consumer preferences. The automaker aims to manufacture 4.5 models at each of its plants by 2015, up from 3.6 models currently.
Automakers are also concentrating on providing optional features (which will save gas) on small vehicles in order to attract buyers. The inclusion of the additional features provide scope for higher revenue generation from small cars, which have lower profit margins relative to large trucks.
In an attempt to reduce costs, automakers continue to shift production facilities from high-cost regions such as North America and the European Union to low-cost regions such as China, India and South America. According to a study by CSM Worldwide, China and South America together will contribute more than 50% of the growth in global light vehicle production between 2008 and 2015.
Apart from individual company strategies, the government plays a pivotal role in molding the future of global auto manufacturers. The energy and environmental policies of different countries will play a major role in shaping the future of the auto industry.
For example, in late 2011, 13 major automakers, including Ford, General Motors, Chrysler, BMW, Honda, Hyundai, Jaguar/Land Rover, Kia, Mazda, Mitsubishi, Nissan, Toyota and Volvo, signed letters of commitment with the U.S. Government to upgrade the fuel economy in cars and light-duty trucks to 54.5 miles per gallon (mpg) by 2025. This has significantly affected the design and cost of new automobiles.
U.S. Market Recovery
Average age of vehicles on U.S. roads reached an all-time high of 11.4 years in Aug 2013. This is resulting in high replacement demand for cars. Moreover, with the improvement in the general economic situation, banks are offering more car loans with lower interest rates.
Strong pent-up demand due to aging vehicles on U.S. roads, easier car financing, low gas price boosted automobile sales in the nation. Improving macroeconomic conditions, such as low interest rates, improving employment rates and recovery of the housing market also contributed to the sales growth.
Auto sales in the U.S. grew 13.4% to a five-year high of 14.5 million vehicles in 2012. The strong performance continued in 2013. In August, auto sales in the U.S. grew 17% to 1.5 million units, which is the highest since May 2007. Sales during the month rose to 16.1 million vehicles on a seasonally adjusted rate (SAAR) basis, crossing the 16 million mark for the first time since Nov 2007.
However, auto sales declined 4% to 1.1 million units in September, mainly due to two less selling days in the month than the comparable year-ago period. The inclusion of the Labor Day weekend, which usually witnesses strong sales, in August this year instead of September as usual, also hampered sales. Sales rose 3.4% to 15.3 million vehicles on a SAAR basis.
Although the impact of the U.S. government shutdown is a concern, the weak sales figures in September are expected to improve in the next quarter.
General Motors expects full-year sales to exceed its guidance range of 15.0-15.5 million units, while Ford expects annual sales in the range of 15.5-16 million units, compared with 14.5 million units in 2012.
Asia Promises High Growth
The Asian countries, especially China and India, are expected to account for 40% of growth in the auto industry over the next five to seven years.
Ford expects the potential growth in Asia, mainly China and India, and rising demand for small cars to boost its global sales by 50% to 8 million vehicles by 2015. The automaker anticipates small cars to account for 55% of the total sales by 2020 compared with 48% presently. One-third of the small car sales are expected to come from Asia.
During late 2012, Ford decided to ship engines produced in India to Europe, to boost export. Currently, the automaker exports 40% of its Indian-made engines and 25% of its Indian-made cars to 35 countries. The company expects to manufacture 450,000 cars and 600,000 engines in India by 2015. It has already pumped in $2 billion to build manufacturing facilities in the country.
Meanwhile, Ford plans to triple its line-up in China by introducing 15 models by 2015. In June, Ford opened a new assembly plant in China in collaboration with Jiangling Motors Corp. which doubled its production capacity in the country.
General Motors has also decided to boost the annual production capacity in China to 5 million vehicles and triple its exports from Chinese plants by 2015. In April, the company revealed plans to build four plants in the country to boost capacity. General Motors and its joint venture partners in China plan to invest $11 billion in the country by 2016 and launch about 17 new and upgraded car models as part of their major expansion program.
Last year, General Motors built two plants in China to increase the production capacity by 20%. With the addition of four new plants, the production capacity will increase further by 30% and vehicle exports are expected to rise to 300,000 units from 100,000 units projected for this year.
Even Tesla (NASDAQ:TSLA) is seeking a share in the lucrative Chinese market and started the reservation of Model S in the country in August. Although the car is expected to be popular among the wealthy and environmentally conscious consumers in China, high tariffs on imported cars and shortage of charging stations could affect sales.
In 2009, China overtook the U.S. as the biggest auto market in the world by sales volumes when the Beijing government introduced a stimulus package, including tax incentives for small cars. China accounted for a third of light vehicle sales growth in the last five years.
However, the incentives were scrapped in 2011 and the Beijing government imposed quotas on new car registrations in order to control traffic congestion. As a result, sales in China grew 4.3% in 2012, lower than the 8% growth projected by the China Association of Automobile Manufacturers (CAAM) as well as the double-digit growth in 2009 and 2010.
Nevertheless, the nation has managed to regain its position as the world's largest automobile market. Automobile sales in China increased for the fourth consecutive month in Aug 2013, after months of sluggish growth due to weak economic conditions and restrictions imposed by the government on new vehicles.
The total vehicle sales in China witnessed year-over-year growth of 10.3% in August compared with 9.9% in July, according to CAAM. The Aug 2013 vehicle sales in China surpassed the sales of 1.5 million units in the U.S. and 0.07 million units in the U.K.
CAAM expects automobile sales in China to cross the milestone of 20 million units for the first time this year, led by strong demand due to economic recovery and lower prices, along with increasing demand from unsaturated markets of smaller cities. Moreover, prospective buyers are trying not to delay their purchase due to the possibility of increased regulations on new vehicle registration in Beijing.
Bailout Fund Repayments
General Motors Company and Chrysler received $62 billion from the U.S. government under the Troubled Assets Relief Program (TARP). A significant portion of the amount has been repaid by General Motors out of its $49.5 billion loan and by Chrysler out of its $12.5 billion loan.
While the U.S. Department of Treasury has recovered $11.2 billion out of its investment in Chrysler, the remaining $1.3 billion is not expected to be retrieved. Meanwhile, the department recently rolled out the third phase of divesting its stake in General Motors. The department plans to sell the remaining shares of the automaker by Apr 2014.
The U.S. Department of Energy (DOE) also lent more than $8.5 billion to a few automakers under the Advanced Technology Vehicles Manufacturing (ATVM) Incentive Program in order to reduce dependence on oil, curb greenhouse gas emissions and to create new jobs.
Ford utilized the DOE loan for retooling two plants for the production of small cars and developing fuel-efficient vehicles like Ford Focus EV and C-Max Energi plug-in hybrid. The automaker is repaying the loan in equal quarterly installments of $148 million and the full amount is expected to be repaid by Jun 15, 2022.
In May, Tesla became the first DOE loan recipient ($465 million) to repay the full amount. Although the loan was repayable in quarterly installments till Dec 2017, the electric vehicle maker made an advance repayment of the entire outstanding balance using the proceeds from a common stock and convertible senior note offering.
Repayment of bailout funds is enhancing the financial flexibility and credit worthiness of these companies. The decline in debt will allow the companies to invest freely in growth opportunities.
Although automakers continue to focus on shifting their production facilities to new regions driven by cost and demand factors, developing supplier networks in these unfamiliar regions remains one of their greatest challenges. Existing suppliers to automakers often lack the financial strength to expand capacity in the new markets. On the other hand, auto parts suppliers are sensitive to technology transfers to local third parties, which can give rise to low-cost competitors.
High dependence on automakers makes the auto market suppliers vulnerable to pricing pressure and production cuts. Pricing pressure from automakers constricts the margins of parts suppliers. On the other hand, production cuts by automakers, driven by frequent market adjustments, negatively affect their operations.
Some of the auto industry suppliers who are highly dependent on a few automakers such as General Motors, Ford, Chrysler and Volkswagen include American Axle and Manufacturing Holdings Inc. (NYSE:AXL) , Meritor Inc. (NYSE:MTOR) , Goodyear Tire and Rubber Co. (NYSE:GT) , Magna International Inc. (NYSE:MGA) , Superior Industries International Inc. (NYSE:SUP) , Tenneco Inc. (NYSE:TEN) and TRW Automotive Holdings Corp. (NYSE:TRW) .
Future of Green Cars Looks Bleak
Rising fuel prices and global warming have turned attention to cars that either rely less on traditional fossil fuels or use cheaper renewable sources of energy. Despite the U.S. Government's continued effort to promote green alternatives such as fuel-efficient electric vehicles (EVs) and hybrid vehicles, prospects look bleak, at least in the near future. High car prices, a shortage of charging stations and improving fuel economy of non-hybrid cars are some factors that are hurting the sales of hybrid and electric cars.
Globally, the hybrid market is ruled by Toyota (which includes Prius and Camry) and Honda (includes Civic and Insight hybrids). Meanwhile, other automakers such as Ford, General Motors and Nissan are also aggressively trying to drive hybrid sales.
Some of the well-recognized "green" cars include Tesla Model S; Ford Focus, Fusion and C-MAX; Chevrolet Volt; Nissan Leaf and Daimler AG's (OTCPK:DDAIF) smart micro EV. U.S. and Japan are the largest hybrid car markets in the world, while Europe is also emerging as a lucrative market.
However, the industry has witnessed some notable adverse developments in the drive for green technology. In Jan 2013, the DOE backed off from President Obama's stated goal of putting 1 million electric cars on the road by 2015 due to weaker-than-expected demand for plug-ins/EVs. According to Hybridcars.com, plug-in/EV sales constituted a meager 3.3% of the overall sales in the U.S. in 2012.
The weak demand for plug-ins/EVs forced some lithium-ion battery makers to file for bankruptcy protection in 2012. They include A123 Systems Inc. and EnerDel, both of which were DOE grant recipients (A123 - $249.1 million; EnerDel - $118.5 million). It also led to writing down of the value of the third largest DOE grant recipient ($161.0 million), Dow Kokam, by chemical behemoth Dow Chemical (NYSE:DOW) , which jointly operates the entity with TK Advanced Battery LLC since 2009.
Most of the major automakers have been plagued by a series of product recalls in recent years. The biggest victim of this problem is Toyota, which has announced at least 5 product recalls for more than 2.5 million vehicles in the last quarter alone. The most damaging among them was the repeat recall of 780K vehicles to fix a problem in the rear tie rod. While vehicle recalls are very common among automakers, a second recall for the same problem might affect consumers' confidence in Toyota.
Automotive safety recalls were brought into focus by media after Toyota's announcement of the then-largest global recall of 3.8 million vehicles in Sep 2009, triggered by a high-speed crash that claimed 4 lives. Later, in Oct 2012, the automaker announced a major worldwide recall of 7.43 million vehicles that included more than a dozen models manufactured between 2005 and 2010.
In Dec 2012, the U.S. Transportation Department slapped a $17.35 million fine on Toyota due to late response to safety regulators and delay in recall regarding a defect in its vehicles. According to safety regulators, it was the maximum allowable fine under the law for not initiating a recall in a timely manner. This was not the first time the company incurred heavy fines. Toyota also suffered a fine of roughly $48.4 million in 2010, imposed by the U.S. government, due to late recall of millions of defective vehicles.
Toyota also agreed to a $1.1 billion settlement of a class-action lawsuit related to complaints of unintended acceleration in its vehicles. According to a plaintiff lawyer, the settlement is one of the largest in the history of automotive industry.
In the spate of recalls following Toyota's, other automakers' recalls also came into the limelight. They included Chrysler, Ford, General Motors, Honda and Nissan. While Ford announced 4 product recalls in the last quarter for a total of 1.5 million vehicles, General Motors had 3 recalls for around 0.41 million vehicles and Honda had 2 recalls for about 0.8 million vehicles.
Economic Crisis in Europe
The Eurozone financial crisis adversely affected the operations of many global automakers, especially General Motors and Ford, who have a significant exposure to the market. Car sales in Europe continued to be low due to weak consumer confidence following a weak economy.
According to the European Automobile Manufacturers' Association (ACEA), car sales in Europe reached 12.05 million units in 2012, its lowest level since 1995. Sales declined 8.2% year over year, as highly indebted banks were reluctant to finance new car purchases. The decline was the steepest in the highly troubled Eurozone, where car sales dipped 11.3% to roughly 9 million units, according to Reuters.
Most of the major automakers in Europe resorted to job cuts and plant closures, as it was no longer feasible for them to undertake full-fledged operations in the continent. Among the U.S. automakers, Ford announced plans to cut production capacity by 18%, retrench 6,200 jobs and close three facilities in Europe.
General Motors also took several initiatives to sustain profitability, including closure of an auto factory in Germany in 2014, reduction of workforce and pay freeze across Europe. However, it recently announced plans to invest 130 million euros ($175.4 million) in its German engine and parts plant in Kaiserslautern.
Among the European automakers, Renault announced plans to retrench 7,500 jobs in France by 2016, while both Fiat and Peugeot decided to eliminate 1,500 jobs each. Among the Japanese automakers, Honda announced plans to terminate 800 jobs at its South Marston plant near Swindon, southwest England.
Unemployment in the European Union reached 26.6 million in Aug 2013, while the seasonally-adjusted unemployment rate increased to 12% in the same month from 11.5% in Aug 2012.
However, with the recent improvement in the European economy, things are beginning to look up for automakers. Car sales in Europe seem to have bottomed out and are expected to rise gradually with economic recovery in the Eurozone, although the process is expected to be slow. In fact, car sales in Britain, Poland, France and Spain witnessed improvements in September, although sales in Germany declined. Rating agency Moody's expects light vehicle sales in Europe to decline 5% in 2013.
Labor Union Woes
Frequent demands for wage hike and strikes by labor unions are matters of concern for automakers. The recent four-week strike by a labor union in South Africa led to significant losses for automobile manufacturers as well as the South African economy. While Toyota lost over 700 car production daily, BMW lost almost 350 sedans. Nissan's daily output of almost 250 units in South Africa was also affected. The strike is estimated to have cost the industry almost 20 billion rand ($2 billion).
The strike by workers in the automobile manufacturing business was followed by a labor strike in the auto components industry, which also lasted for four weeks. The strikes have forced car makers to rethink their investment strategies for the nation. Last week, BMW announced the cancellation of its plans to expand in South Africa.
However, South Africa is not the only country where automakers are facing labor problems. General Motors has been facing trouble with labor unions in South Korea recently. Labor strikes in July resulted in production losses of over $90 million, forcing the company to reach a wage settlement, including yearly bonuses of 10 million Won ($9,000 million) per member. This resulted in media reports that the company is planning to wind up its operations in the nation.
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