Smooth Ride Ahead For Auto ETF?

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Includes: CARZ
by: Zacks Funds

The auto industry started to lose steam after seven years of growth as demand for new cars, pick-up trucks and SUVs is falling. This is especially true as car sales dropped 4.7% year over year to 1.4 million vehicles in April, representing the fourth consecutive monthly decline. This represents the longest stretch of decline since 2009 and an end to the seven-year auto boom.

Seasonally adjusted annual sales fell to 16.88 million vehicles, down from the analyst expectation of 17.2 million polled by Reuters.

All the six major American and Japanese automakers reported weaker sales with Ford Motor (NYSE:F) recording the biggest drop of 7.1%, followed by a decline of 7% for Honda (NYSE:HMC), 6.6% for Fiat Chrysler (NYSE:FCAU), 5.8% for General Motors (NYSE:GM), 4.4% for Toyota (NYSE:TM) and 1.5% for Nissan (OTCPK:NSANY). Fiat Chrysler has a Zacks Rank #2 (Buy) while Ford and General Motors carry a Zacks Rank #3 (Hold). The other three automakers have a Zacks Rank #4 (Sell).

The disappointing numbers can be traced back to increased inventories, especially of small cars and higher discounts. Headwinds like chances of higher interest rates and growing vehicle stockpiles continued to weigh on demand for new cars. Additionally, the industry is expected to take a hit from Trump's policies of "big border taxes" on imported vehicles.

ETF Impact

The lone auto ETF - First Trust NASDAQ Global Auto Index ETF (NASDAQ:CARZ) - shed 0.8% following the weak car sales report. It offers a pure play global exposure to 33 auto stocks by tracking the NASDAQ OMX Global Auto Index. It is a large cap centric fund with high concentration on the in-focus four firms - Toyota Motor, Honda, General Motors and Ford - which account for over 7% share each. CARZ has a lower level of $18.1 million in AUM and trades in a small average daily trading volume of about 10,000 shares. The product charges 70 bps in fees per year and has a Zacks ETF Rank of 3 with a High risk outlook, suggesting room for upside.

Favorable Outlook

Despite the slide, the current trends are still favorable for automakers, given that the U.S. economy is clearly on solid ground thanks to an impressive labor market, rising wages, slowly rising inflation and increasing consumer spending. Americans have an optimistic view about the economy with confidence soaring to a more than 16-year high.

Additionally, higher demand for light trucks and SUVs, a plethora of new models, fuel-efficient and technologically enriched vehicles, and the need to replace aging vehicles should lift car sales in the coming months.

Further, Q1 earnings for the auto sector in the S&P 500 have been faring well, with 90% of the companies beating our estimates on both the top and bottom lines. While earnings have trended lower with a decline of 7.3%, revenue growth of 3.6% looks impressive. In particular, Ford topped our estimates by 14.71% on earnings and 4.88% on revenue, while General Motors beat our earnings and revenue estimates by 17.24% and 2.36%, respectively. Honda also came up with a huge surprise of 123.81% on earnings and 7.55% on revenues.

Moreover, the auto sector has a solid Zacks Rank in the top 27% and the valuation looks appealing at the current level with a P/E ratio of 12.26, the lowest of all the 16 Zacks sectors. All these have set the stage for a rebound in auto sales in the coming months.

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