Running Out Of Gas: The Direction Of The Auto Industry

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Includes: F, FCAU, GM, TSLA
by: Kyla Scanlon
Summary

The auto industry is showing signs of weakness through compressed sales figures and job losses.

Automakers didn't pay enough attention to consumer demand for SUVs, and they have to be careful not to repeat that error with electric vehicles.

There are several things disrupting the industry, such as autonomous vehicles, ride-sharing, and Tesla.

The auto industry always seems to be a predictive measure of weakness in the economy. If auto sales fall, we can use that to project consumer spending, which represents 2/3rds of the overall economy. However, auto stocks have moved downward the past year, despite ideal economic conditions. There has been a slump in sales figures, even with a boost from fleet sales, especially across American automakers. There are several reasons for this decline, including quantitative tightening, job losses, heightened competition, weakness overseas, and the trade war.

The Attempt at Quantitative Tightening: Higher Interest Rates

Low interest rates have been fuel to the automobile purchasing fire over the past several years. People have taken advantage of cheap credit and pushed the total number of outstanding auto loans to above $1 trillion, which is a 64% increase since 2010. The United States and the rest of the world are attempting to ease out of quantitative easing, with the Fed planning to hike interest rates two more times in 2019, as of now.

federal loans rate

Source: FRED

Rising interest rates will compress the ability of consumers to take out loans to purchase vehicles, putting pressure on US auto sales, and threatening the cheap credit that so many took advantage of when purchasing their vehicles. Rates are still historically extremely low, but combined with other factors, it has led automakers to enact plant shutdowns, resulted in job losses, and dampened sales forecasts.

Driving into a Thunderstorm: Shutting Down Plants, Cutting Jobs

General Motors (GM) cut 15% of their workforce and closed three plants and two facilities back in November 2018. Ford (NYSE:F) also plans to cut 20,000 jobs in part of an $11 billion restructuring plan. Jaguar Land Rover also slashed jobs overseas.

It could be argued that the automakers are too big. The plants that they run have the production capacity of many more vehicles than they are able to sell. Automakers sold 17 million new vehicles in 2018, approximately the same amount as 2017. This is the fourth straight year above 17 million vehicles, and many expect that number to decline into 2019.

market of automakers

Source: Charlie Bilello

However, despite maintaining sales numbers for the year, the companies have been pretty beat up over the course of 2018. It's becoming difficult to retain relevance in the era of foreign automakers on US soil, not to mention the advent of autonomous cars, ride-sharing, and shifting consumer preferences.

Fiat Chrysler (NYSE:FCAU), in comparison to its other American counterparts, is up 161% after dropping out of the sedan market entirely in 2016. Fiat Chrysler owns both the Jeep and Ram lines, which dominate the sportier side of the SUV and truck segment of the market.

FCAU'S gamble on not producing sedans anymore has seemed to pay off, with the Ram truck winning 2018 Truck of the Year. Ford and GM are following FCAU's lead, with Ford planning to ax every car except for the Mustang, while at the same time, planning to grow their lineup by three crossovers and SUV models by 2023.

GM had planned to stick with the sedan market, but factory closures have led them to pull several of their top models out of the lineup, such as the Chevrolet Impala and the Buick LaCrosse. They plan to still produce the Chevy Malibu and more Cadillac sedans in the future.

However, sedans and small-cars will still make up 30% of the overall auto market, and foreign automakers are planning to capitalize on that. Sedans are great cars for first-time drivers, and they are usually cheaper to gas up and maintain. SUVs carry a higher profit margin, but sedans still maintain a lot of relevance in the market.

The Competition: Foreign Automakers

Foreign automakers currently operate 19 plants inside the United States, which enables them to avoid currency fluctuations and overseas shipping costs. It has also helped bolster their market share in the US, with foreign automakers accounting for more than 50% of all vehicles sold in the United States. GM, Ford, and Fiat Chrysler, the Big Three, now control 44% of the US market, down from 74% thirty years ago.

Toyota (NYSE:TM) sales fell by less than half of a percent over the course of 2018, with the ever reliable Toyota Corolla helping bolster the company's sales. The RAV4 and Tacoma also led the way in crossover and truck sales. Nissan (OTCPK:NSANY), which was plagued by the arrest of former CEO and Chairman Carlos Ghosn, saw a decline of 6.6% in sales for 2018. However, they had a 7.6% increase in sales for the month of December. They will probably have more problems ahead, as Jose Munoz, former chief performance officer and closely tied to Ghosn, resigned last Friday.

Among the other foreign automakers, Honda (NYSE:HMC) sales were down 2.2% and Hyundai-Kia (OTCPK:HYMLF) sales down 1.1%. Volkswagen (OTCPK:VWAGY) sales up approximately 5.4% (based on year-to-date November data) and Subaru sales were up 5%.

Volkswagen has also entered into a global alliance with Ford, with Ford building trucks for both companies by 2022. The alliance is interesting, letting both companies focus on what they are good at, and could spark similar relationships between more automakers.

sales numbers for autos

Source: USA Today, Author

The Demand Shift: Sport Utility Vehicles

Consumers are also demanding SUVs, which has required a shift from car production. Cars make up 30% of the new vehicle market, a decline from 43% share in 2015. Car sales are expected to decline even more over the next six years, composing 21.5% of the market in 2025.

Every nine out of ten vehicles sold in 2020 are expected to be SUVs and other commercial vehicles, primarily driven by cheap financing. But overall, vehicle sales are declining. There was a big uptick in the early part of this decade, but the change year over year has essentially flatlined and has been trending negative for the past three years.

total vehicle sales

Source: Fred

If the economy enters into a correction, or even slows down, auto sales will follow suit. Also, the whole trade war puts further pressure on the industry. Trump attacked GM's decision to cut jobs and close plants, but one of the reasons that they did so was because of higher steel and aluminum prices due to the tariffs enacted.

Rising Input Costs: The Effect of The Trade Dispute

If it becomes more expensive to produce vehicles, the automakers will have trouble keeping up. Raw material prices increased by 10% over the past year, which impacts production costs. There is also a 10% tariff on imported aluminum. Steel has a 25% tariff. Separately, due to an increase in feed costs, plastic resin prices rose 31%.

raw materials

Source: Auto News

Ford and GM said that the tariffs cost them $1 billion in profits. Automakers normally carry long-term contracts with suppliers, so rapidly changing policies can be quite painful. The US imported 5.5 million tons of aluminum in 2017, with domestic production totaling 740k tons. The US imports 86.5% more aluminum than it makes, so it would take time to adjust to not importing the product, and avoiding the impact of the tariffs.

Also, the rising costs of materials have to be passed off to consumers, as noted by GM's Chief Financial Officer. SUVs, which are more expensive in general, can offset some of the costs, as they tend to carry wider margins, but things might change as the higher priced materials continue to work their way through the supply chain.

Also, there was a Trump proposal to reduce emissions targets, which could be painful in the transition into electric vehicles. In Europe, the opposite is happening with new auto emission rules, and in Asia, China has a massive demand for greener vehicles. It is entirely necessary for automakers to continue paying attention to electric vehicles.

Electric Vehicles and Tesla (NASDAQ:TSLA)

The industry itself is evolving in the direction of electric vehicles. Traditional manufacturing jobs are slowly being replaced by high-tech engineering careers. Producing an electric car does not require as many workers as a traditional car does, according to Dr. Aston Bailey, a professor at Aston University.

There is also a global drive towards emission caps and creating vehicles to be more environmentally friendly. The electric vehicle market currently accounts for 3% of the total passenger car market, with total sales of over 2.8 million cars. It is expected to grow tremendously in the coming years.

electric vehicles

Source: National Geographic

Then there is Tesla, who specializes in electric vehicles. They are the first Western carmaker to build a plant in China that isn't part of a joint venture. In the age of tariffs and painful shipping costs, it makes sense for Tesla to integrate in China, just as foreign car makers have done in the US. Tesla seems to thrive on risk, and entering into China when the country seems to be on the verge of slowing down, might be the best decision they've ever made.

China is the world leader in electric vehicle (EV) sales. They have rules that require carmakers to "sell 30,000 or more cars a year to make fleets with increasingly higher fuel economies by 2020 and 2025" which Tesla already has a head start on.

Chinese car sales were down -4.1% in 2018, as compared to 2017 numbers, after 6 months of steady declines. The recent downturn in the Chinese stock market and Beijing's attempt to compress debt are drivers of the decline in auto sales. However, on the flip side, electric vehicle sales are on the rise due to government subsidies and increasingly gain more market share.

electric vehicles dominate in china

Source: Manufacturing.net

There are also "boutique" electric vehicle companies, like SF Motors and Rivian, among others. They operate in a niche segment in a big industry, and it seems that the efforts are paying off. Faraday Future was a leader back in 2016, with their notorious bat-mobile. NIO has already entered into China, going public last year with a $6.4 billion valuation.

The problem that the more niche EV companies will have as compared to the big automakers is production costs. Tesla infamously struggles with putting enough vehicles out to market, at a profitable scale. So if GM, Ford and the other top dogs can somehow create EVs efficiently, and create EVs that people want to buy, they should be able to slide their way into a spot in this segment of the industry.

Ford is planning to invest $11B in EVs, and GM is planning to produce an all-electric Cadillac in the future. The companies are making effort in the right direction, but there are still outside variables, such as driverless cars and ride-sharing apps, that will also create barriers.

Autonomous Vehicles and Uber

A Stanford economist, Tony Seba, predicts that 95% of all passenger miles will be autonomous by 2030. Seba believes that fleets will take advantage of the ease of maintenance and manufacturing process of electric vehicles, which will help get more of them on the road. The timeline seems short for such a change, but in hindsight, a lot has happened in the past ten years with regard to vehicle innovation.

Ridesharing and carsharing are also two forces that have popped up in recently. Uber (UBER) and Lyft (LYFT) are evolving rapidly, and could potentially disrupt the auto industry. Fancy features on vehicles do not matter to those who are just using the vehicle to get around town, especially if they don't own it. They just need a ride from point A to point B.

demographics of car purchases

Source: WSJ

Also, from a demographic perspective, younger generations are about 30% less likely to buy a car as compared to older generations. Low gas prices and an uptick in wages has made driving more affordable, but the Millennial and Gen Z generations have both student loan debt and increased housing costs that compress their ability to buy cars. They are also more comfortable using apps like Uber and Lyft as a means of transportation, further reducing the need for a car.

Conclusion: Uncertainty Within the Auto Industry

There are definite headwinds within the auto industry. There is a process of adapting to change, which of course takes time. Automakers sometimes take too long to adapt and end up being left behind. There is increasing competition, political pressures, and demographic shifts.

The companies that can maintain relevance, and produce vehicles, or enter partnerships, that can somehow meet all the various market demands will be successful. The Big Three are shifting their resources into SUVs, but are at risk in being left behind in the shift to EV. Foreign automakers are keeping stake in the sedan market, which could prove to be worthwhile if preferences shift back to smaller vehicles. Tesla and other boutique EV companies are taking hold in China and other markets that have the appetite for EVs.

The economy has experienced strong growth, consumers are spending, and unemployment is near all-time-lows. However, Ford and GM were hit hard this year. The Volkswagen-Ford alliance is promising, and the idea of more consolidation and partnerships to focus on individual economies of scale should streamline costs of production across the industry.

All of the auto companies ended 2018 in the red, but most companies market-wide did the same. Tesla was down the least, with a -3.25% decline from January 2018 numbers. Ford was down the most, with a -39.57% decline from January 2018 to December 2018. Ford is up ~12% since the beginning of 2019, more than likely bolstered from the Volkswagen news.

Most of the companies have relatively low PE ratios, besides Tesla, and strong profitability metrics. TSLA leads the way in terms of revenue and EBITDA growth, with 62.93% and 187.46% metrics, respectively. Fiat Chrysler is poised for strong EPS growth but carries a large beta at 2.03 for an automobile stock.

What is appealing about FCAU is that it carries several European lines, such as Alfa Romeo, Fiat, and Maserati as well as American brands such as Dodge, Chrysler, and Jeep. Sergio Marchionne, the late CEO, was credited with turning the company around. The stock had an adjustment period after his passing but currently trades at a PE ratio of 7.08 and a TEV / EBITDA of 2.3x, which is extremely small compared to the industry, and signals potential undervaluation. They have strong cash flows, with $6.8 more in inflows expected due to their Magneti Marelli sale.

The stock offers diversification across different economies, with international as well as domestic exposure. However, Ford is also moving in the right direction, with obvious focus on electric vehicles and a willingness to collaborate with Volkswagen. Ford carries a higher TEV / EBITDA at 11.6x and a PE ratio of 5.96. They carry a beta of 0.67, which might be good if we enter another period of extreme market volatility.

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