Car Manufacturers On Sale: Investment Opportunities In A Growing Market

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Includes: BMWYY, DDAIF, F, GM, NSANF, RNSDF, TSLA, VLKAF
by: Cassiopeia Value Investing

Summary

Investors' fears about the future of mobility caused the decline of car stocks since 2015, the year of Volkswagen's emission scandal.

Electrification, autonomous driving and new competitors are the main challenges for the long-established car brands.

The combination of lower margins (increasing investments) in the short term and higher revenues & earnings (growing car sales) in the long term creates a promising investment opportunity.

1. Introduction

On September the 18th in 2015, Volkswagen (OTCPK:VLKAF) was accused of violating the Clean Air Act: Clean Air Act.

It was the start of a never-ending story of accusations against many car manufacturers all over the world. Not only Volkswagen cheated but also Daimler (OTCPK:DDAIF), BMW (OTCPK:BMWYY), Ford (F), Nissan (OTCPK:NSANF), Renault (OTC:RNSDF), Mazda and Suzuki.

The customers lost their confidence in the automobile industry and investors around the globe more and more shunned the stocks of this sector. The negative sentiment even increased last week after Daimler issued a profit warning.

Daimler, Ford and BMW expect lower earnings this year as a consequence of conversion costs, restructuring (Ford) and a lower availability of some models due to the new WLTP emission test.

These problems caused a sharp price decline of car stocks over the last three years. As if this wasn't enough, new competitors entered the market and especially Tesla, one of the most hyped stock for the last decade, attracted public attention because EVs are the future of mobility.

Nevertheless, the traditional car manufacturers are investing heavily which lowers the margins in the short term, but in the long term they are facing a bright future as a result of a growing car market.

2. Global car sales

First, let us have a look at the development of global car sales since 1990.

Comparing the data for different decades an upward trend in global car sales can be identified. While in the 90s, the average sales per annum were below 40 million units, the average sales rose to over 50 million in the first 14 years of the new century. From 2015 to 2018, the annual car sales rose from 72.6 million to over 81 million (2018: expected). This is kind of surprising! The car industry is constantly growing for nearly 30 years, including the Financial Crisis in 2008-09. So on the one hand, the industry faces several problems and challenges (see above), on the other hand, the car industry is growing and profitable. Bears could argue now that we are at the end of a up cycle and the next years will be disappointing. This is a valid argument and it seems to be true because in 2018, car sales stagnate and just grow for some manufacturers.

Sales of new vehicles by type in 2018 vs. 2017 - USA

Type 2018 2017 Y-o-Y 2018 2017 Y-o-Y
Sep. Sep. Jan.-Sep. Jan.-Sep.
Passenger Cars

440,075

554,930

-20.7%

4,176,305

4,844,059

-13.8%

Light Trucks (Pickup Truck, SUV)

991,994

968,937

2.4%

8,719,206

8,030,417

8.6%

Total

1,432,069

1,523,867

-6.0%

12,895,511

12,874,476

0.2%

Source: MarkLines Data Center
USA - Sales of passenger cars and light commercial vehicles

Sep. 2018 Sep. 2017 y-o-y Jan.-Sep.
2018
Jan.-Sep.
2017
y-o-y
Share
fluctuation
Share
fluctuation
GM (Est.) Total

234,043

279,176

-16.2%

2,166,938

2,193,698

-1.2%

Share

16.3%

18.3%

-2.0 pt

16.8%

17.0%

-0.2 pt

Toyota Total

203,098

226,632

-10.4%

1,824,235

1,831,482

-0.4%

Share

14.2%

14.9%

-0.7 pt

14.1%

14.2%

-0.1 pt

FCA Total

199,819

174,266

14.7%

1,679,983

1,579,138

6.4%

Share

14.0%

11.4%

2.5 pt

13.0%

12.3%

0.8 pt

Ford Total

196,496

221,643

-11.3%

1,878,653

1,924,387

-2.4%

Share

13.7%

14.5%

-0.8 pt

14.6%

14.9%

-0.4 pt

Honda Total

132,668

142,722

-7.0%

1,206,997

1,231,603

-2.0%

Share

9.3%

9.4%

-0.1 pt

9.4%

9.6%

-0.2 pt

Nissan Total

122,819

139,932

-12.2%

1,124,682

1,196,241

-6.0%

Share

8.6%

9.2%

-0.6 pt

8.7%

9.3%

-0.6 pt

Hyundai Total

57,359

57,007

0.6%

501,701

511,740

-2.0%

Share

4.0%

3.7%

0.3 pt

3.9%

4.0%

-0.1 pt

Subaru Total

57,044

55,120

3.5%

503,418

478,848

5.1%

Share

4.0%

3.6%

0.4 pt

3.9%

3.7%

0.2 pt

Kia Total

51,503

52,468

-1.8%

452,042

457,930

-1.3%

Share

3.6%

3.4%

0.2 pt

3.5%

3.6%

-0.1 pt

Mercedes *1 Total

30,617

32,096

-4.6%

253,414

267,477

-5.3%

Share

2.1%

2.1%

0.0 pt

2.0%

2.1%

-0.1 pt

VW Total

30,555

32,112

-4.8%

266,228

252,456

5.5%

Share

2.1%

2.1%

0.0 pt

2.1%

2.0%

0.1 pt

BMW Total

25,908

25,571

1.3%

225,065

220,175

2.2%

Share

1.8%

1.7%

0.1 pt

1.7%

1.7%

0.0 pt

Mazda Total

21,257

25,738

-17.4%

235,122

220,297

6.7%

Share

1.5%

1.7%

-0.2 pt

1.8%

1.7%

0.1 pt

Audi Total

19,319

19,308

0.1%

167,389

160,914

4.0%

Share

1.3%

1.3%

0.1 pt

1.3%

1.2%

0.0 pt

Tesla (Est.) Total

14,100

3,350

320.9%

64,150

33,280

92.8%

Share

1.0%

0.2%

0.8 pt

0.5%

0.3%

0.2 pt

Volvo Total

8,715

7,900

10.3%

73,929

56,966

29.8%

Share

0.6%

0.5%

0.1 pt

0.6%

0.4%

0.1 pt

Mitsubishi Total

7,705

8,430

-8.6%

93,398

79,195

17.9%

Share

0.5%

0.6%

0.0 pt

0.7%

0.6%

0.1 pt

Land Rover Total

6,966

6,407

8.7%

65,133

54,481

19.6%

Share

0.5%

0.4%

0.1 pt

0.5%

0.4%

0.1 pt

Porsche Total

5,102

5,059

0.8%

42,626

41,237

3.4%

Share

0.4%

0.3%

0.0 pt

0.3%

0.3%

0.0 pt

MINI Total

3,461

3,736

-7.4%

34,193

34,787

-1.7%

Share

0.2%

0.2%

0.0 pt

0.3%

0.3%

0.0 pt

Jaguar Total

2,040

3,296

-38.1%

21,176

30,228

-29.9%

Share

0.1%

0.2%

-0.1 pt

0.2%

0.2%

-0.1 pt

smart Total

98

241

-59.3%

959

2,635

-63.6%

Share

0.0%

0.0%

0.0 pt

0.0%

0.0%

0.0 pt

Others Total

1,377

1,657

-16.9%

14,080

15,281

-7.9%

Share

0.1%

0.1%

0.0 pt

0.1%

0.1%

0.0 pt

Grand Total

1,432,069

1,523,867

-6.0%

12,895,511

12,874,476

0.2%

Source: MarkLines Data Center

Some car brands showed strong growth in 2018: LandRover (+19.6%), Mitsubishi (+17.9%), Tesla (+92.8%) while most of the others showed slow growth or stagnated: Ford (-2.4%), BMW (+2.2%), GM (-1.2%).

It seems that Tesla is the big winner here. But if we compare the number of cars which were sold in 2018, the picture is quite different. Tesla just sold 64,150 units, a market share of 0.5% while BMW kept its share of 1.7% with over 225,000 units. GM sold over 2 million units and defended its market leader position. The US car market grew 0.2% so far in 2018. These numbers are not really disappointing or alarming for the established automakers.

For the next few years we cannot expect high growth because of the recent boom years and record sales. The worst case would be a car sales decline which is more likely than a sales increase. Furthermore, all automakers must invest in new technology, electrification and production capacity expansion. But why do they have to increase their capacities while sales are likely to decrease? Because they will just decrease in the short term.

3. The future looks bright

Once the investments will decrease (because the big car manufacturers will adapt to the trends and will offer a wide range of EV models and solutions for people who do not want to drive on their own or want to drive with other people [autonomous driving, sharing economy]), margins will improve again. Bears will argue that these trends will lead to decreasing car sales and hence, lower revenues and earnings. They also argue that a high proportion of EVs will be sold by Tesla so that other car manufacturers won't get a slice of the cake. At least for Europe, this is not true: The table shows that the alliance of Renault and Nissan is the most successful EV seller in Europe in 2018 (35,474 units). BMW is also very successful adding the numbers for all BMW models from the list (29,797 units). Tesla's models S and X add up to just 13,379 units. So traditional automakers which already have better production capacities are selling more EVs than Tesla. In China the EV market is quite different. Chinese brands dominated in 2018:

China July 2018 YTD EV Market Share
1 BAIC EC-Series 500 40,406 9%
2 BYD Qin PHEV 4,068 27,013 6%
3 BYD Song PHEV 2,408 23,609 5%
4 JAC iEV S/E 3,853 21,400 5%
5 BYD e5 3,056 19,678 4%
6 SAIC Roewe Ei6 PHEV 3,783 18,973 4%
7 JMC E200 2,121 16,070 4%
8 SAIC Roewe eRX5 PHEV 2,242 15,586 3%
9 BAIC EX-Series 3,002 15,202 3%
10 Chery eQ 3,665 15,180 3%
11 Geely Emgrand EV 2,500 13,799 3%
12 Zhidou D2 EV 343 12,780 3%
13 SAIC Roewe Ei5 EV 2,939 12,707 3%
14 Hawtai EV160 3,113 12,568 3%
15 SAIC Baojun E100 602 11,127 2%
16 Zotye E200 1,919 9,279 2%
17 BAIC EU-Series 1,618 9,140 2%
18 Tesla Model X e) 1,600 7,869 2%
19 Chery eQ1 7,238 2%
20 BYD Tang PHEV (Gen. I & II) 3,551 6,835 2%
Others 28,251 134,864 30%
TOTAL 75,134 451,323

100%

Interestingly, Tesla just achieved 2% market share while China was dominated by BYD, BAIC, Geely and SAIC. Daimler currently cooperates with BYD, Geely and BAIC. Audi, a subsidiary of Volkswagen, cooperates with SAIC. German car manufacturers are not only successful in the traditional car market, their Chinese partners also dominate the EV market.

All in all, the electrification of cars is not a problem for the "old" automakers, it is their future and most of them, especially the Germans, are well-positioned to profit from EVs in the future.

But what about the fear of declining global car sales? PwC expects global car sales to rise sharply by 2030.

"Across Europe, sales could rise by 34% ... from around 18 million to just over 24 million units. [...]

For the US there could be growth of 20% and new car sales of almost 22 million in 2030.

For China, a rise of over 30% to 35 million units sold is expected."

These are stunning numbers. They mean that in 2030, 81 million cars will be sold in Europe, USA and China. All the other countries are not included in this calculation. in 2018 nearly 81 million cars will be sold in all countries. The study of PwC says that the number of cars needed will grow because of new concepts of transportation and new customer desires. If the automakers can fulfill the desires and adapt to the new concepts, they will strongly profit from the rising car demand.

4. Valuation

In the following, three possible scenarios for car manufactureres will be discussed briefly. The first scenario assumes a sharp decline in global car sales of 30% by 2030. The second scenario assumes a stagnation or very slow growth by 2030 and the third scenario assumes a strong growth (30% or more) in global car sales by 2030.

Starting point

First, let us look at the earnings history, revenues and dividends of the biggest car stocks. For my analysis, I include Daimler, BMW preferred, Volkswagen, GM, Ford, Tesla, Nissan and Renault as representative examples for the whole sector. Prices as of 10/21/2018.

Currencies: € (DAI,BMW,VW,NIS), $ (GM;FORD;TSLA)

Stock Price

EPS

'16

EPS

'17

EPS

'18(e)

P/E CAPE RPS P/S

Dividend

per share

yield

(%)

DAI 51.5

7.97

9.84

8.2

6.3 8.7 154.7 0.30 3.65 7.1

BMW

65.2

10.5

13.1

10.5

6.2 7.9 133.8 0.48 4.02 6.2
VW 144.1

10.3

22.7

25.6

5.6 7.0 476.2 0.28 3.96 2.7
GM 31.2

6.12

-1.16

6.4

4.9 10.6 104.3 0.30 1.52 4.9
FORD 8.35

1.86

1.16

1.5

5.6 4.7 38.3 0.21 0.60 7.2
TSLA 260.0

-4.68

-11.8

-8.4

neg. neg. 70.3 3.70 0.00 0.0
NIS 7.8

0.96

1.28

1.4

5.3 13.0 20.2 0.39 0.39 5.0
REN 66.9

12.57

18.87

14.5

4.6 7.8 220.0 0.30

3.55

5.4

The valuations of all car stocks apart from TSLA are very low. They all have a P/E lower than 7 and also trade below book value or near fair book value (GM= PB of 1.25). It is also notable that all dividends are well covered by earnings.

Scenario 1: Car sales and revenues decline by 30% and as a consequence of lower margins earnings decline 50% by 2030

The first scenario is not very likely (see above) but if we still assume that all car manufacturers (excluding Tesla) will see a decline in earnings of at least 50% while sales will decline by 30%, the stocks are still not very expensive. The earnings multiple would expand from 5.5 to 11x which is not expensive. The average dividend yield today is 5.5% and is well covered by earnings. The yield would decrease to 2.8% if it follows the earnings but this is not very likely. This pessimistic scenario shows that even if earnings and sales will decline, the stocks look attractive. This does not apply to Tesla. The company recently proved that it is able to be profitable but it yet has to show sustainable earnings especially in a downturn. A sales decline could be a real threat to this rising star but at the moment, Tesla is increasing its sales. For our worst case scenario, we assume that Tesla can slightly gain market share which will result in lower revenues and margins for all other carmakers. However, the stocks' down risks are limited due to their cheap valuations.

Scenario 2: Car sales and revenues flat while earnings will decrease in the short term and will increase again by 2030

In the second scenario which is more likely than the first one, the earnings multiple will expand in the short term due to higher costs and investments. Later in the decade, the investments will pay off slowly. The margins will normalize and earnings will increase to today's level. In this case, the dividends can be higher than today (above an average of 5.5%) and the stocks will be extremely cheap (P/E between 5-6). The stock prices have a real upside potential, once the negative sentiment is gone. If book value and earnings return to fair multiples (let's say 1.5x P/B and 10x P/E), the upside potential would be nearly 100% plus a yield of at least 6%.

Scenario 3: Sales and revenues are up more than 30% and earnings will increase 25% by 2030

This would be the best-case scenario and would meet PwC's expectations. All car manufacturers from our list will profit even if Tesla will slightly gain market share. Daimler, BMW, VW, Ford, GM, Renault and Nissan can grow their earnings from today's level by 25% (Tesla impact included) and also raise their dividends. By 2030, investments will be reduced again because most of the capital spending for capacities and technology need to be done in the next three to five years to gear up for future competition. The book values of these companies will also increase. In this scenario the average PE of today's stock prices would decrease to 4.4. Fair value mutiples in this case are 1.8x P/B and 12x P/E) and the upside potential would be 175% plus significant dividend increases. This best-case scenario does not include possible positive effects of the companies' car sharing offers (car2go = Daimler; DriveNow= BMW preferred) which are already part of their business model.

Conclusion

The question is if the glass is half empty or half full. As an optimist and being convinced of the future of cars, I think that the risk reward ratio is very good for the car industry if you choose the "old"-fashioned and out-of-favour stocks. Avoiding Tesla can be a very clever choice looking at the pure numbers.

I would like to conclude with a very intelligent advice of Warren Buffet:

Be greedy when others are fearful and fearful when others are greedy.

For now and for car stocks it seems that there are many fearful investors out there.

Disclosure: I am/we are long DDAIF, F, RNSDF, BMWYY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.