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May 29, 2014 - Automotive Stock Forecast Outlook - by Zacks Investment Research
After a promising 2013, global automobile sales are expected to rise to 85 million units in 2014 from 82.84 million in the earlier year, according to IHS Automotive. Even the 100 million-unit milestone is not far and is expected to be reached in 2018.
Last year, the automobile market recovered significantly from the impact of the global financial crisis, buoyed by economic recovery, pent-up demand in the U.S. and high growth in Asia. Japanese automaker Toyota Motor Corp. (NYSE:TM) retained its market leading position in terms of global sales volume and sold 9.98 million vehicles during the year, up 2% over the 2012 level. General Motors Company (NYSE:GM) and Volkswagen AG (VLKAY) occupied the second and third positions, with sales volumes of 9.71 million and 9.7 million vehicles, respectively.
The upswing is expected to continue in 2014, based on increasing sales in the U.S. and China and slow turnaround of the European market. However, the high incentives being offered by the automakers and increasing recall-related costs are affecting their bottom lines.
Zacks Industry Rank - Positive to Neutral Outlook
The distinctive attributes of the auto industry prompted 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 in the Consumer Discretionary sector (the S&P has 10 sectors versus 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 being Automobile/Trucks and the other Auto Parts.
The current Zacks Industry Rank for Auto-Domestic is #102, Auto-Foreign is at #156, Auto/Truck-Original at #68, Auto/Truck-Replacement at #13, Engines at #3, Retail/Wholesale Auto/Truck at #30 and Retail/Wholesale-Auto Parts at #102. 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 ranges from Positive to Neutral. We rank all 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 1.8% of total S&P 500 earnings in 2014, more than its 1.5% market cap weightage in the index at present.
Looking at the overall result of the Auto sector, earnings fell 22.1% year over year in the first quarter of 2014, compared with the 17.9% year-over-year rise in the previous quarter. Total revenue increased 2.1% year over year in the quarter versus a 4.1% year-over-year gain in the fourth quarter of 2013. The beat ratio was 60% for both earnings and revenues.
Auto sector earnings are expected to be down 2% in the second quarter of 2014 and plunge 18.6% in the third quarter, placing it among the laggards in the whole bunch of 16 sectors covered by Zacks. Revenues are expected to move up 2.9% in the second quarter and 0.8% in the third quarter.
In 2014, earnings are expected to inch up 0.6%, making it the weakest performing sector. Revenue growth in 2014 is expected to be a modest 0.9% for the sector.
For more information about earnings for this sector and others, please read our 'Earnings Trends' report.
Market share concentration among a few companies makes the automobile sector highly competitive. The top 10 global automakers account for nearly 81% of total vehicles sold, according to marketrealist.com. To outperform competitors, automakers are focusing on designing technologically advanced and economically viable vehicles that cater to consumers in both mature and emerging markets.
Automakers are also concentrating on providing optional features in vehicles in order to attract buyers. The sale of these features provides scope for additional 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. Consequently, China is expected to account for 50% of the growth in auto production over the next 7 years, according to the research by IHS Automotive.
Apart from individual company strategies, the governments of different countries and their energy and environmental policies will play a pivotal role in shaping the future of the global auto industry. For instance, in late 2011, 13 major automakers, including Ford Motor Co. (NYSE:F), General Motors, Chrysler, BMW, Honda Motor Co. Ltd. (NYSE:HMC), Hyundai, Jaguar/Land Rover, Kia, Mazda, Mitsubishi, Nissan Motor Co. Ltd. (OTCPK:NSANY), Toyota and Volvo, signed letters of commitment with the U.S. Government to upgrade 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.
Strong U.S. Market
Average age of light vehicles on U.S. roads reached an all-time high of 11.4 years in Aug 2013 and continues to remain close to that level at present. It is expected to rise to 11.5 years by 2018, according to the forecasts made by IHS Automotive.
The high average age is resulting in high replacement demand for cars as well as car parts. Moreover, with the improvement in the general economic situation, banks are offering more car loans with lower interest rates. The availability of car loans plays an important role in increasing car sales in the U.S.
Higher incentives by automakers, pent-up demand due to aging vehicles and easier car financing are boosting automobile sales in the nation. Improving macroeconomic conditions, such as low interest rates, rising employment rates, growing consumer confidence and recovery of the housing market are also contributing to the sales growth.
Auto sales in the U.S. grew 8% to a 6-year high of 15.6 million vehicles in 2013. Although extremely cold weather led to a decline in U.S. auto sales in January and February, sales picked up thereafter. Improvement in the U.S. auto sales in the last two months is expected to continue in the months ahead, backed by a strong outlook for 2014.
Toyota and Ford expect the growth rate to slow down in 2014. Ford expects the U.S. industry volume to range between 16-17 million units in 2014, while Toyota expects it to be about 16 million. Meanwhile, GM expects industry sales in the range of 16-16.5 million in 2014.
High Growth Prospects in Asia
Asian countries, especially the rapidly growing Chinese and Indian economies, are expected to account for a large portion of the growth in the auto industry over the next 5 to 7 years. China is the biggest and fastest growing auto market in the world in terms of number of vehicles sold. In 2013, it became the first nation to surpass domestic auto sales of 20 million units. Sales are expected to be even higher in 2014, based on the statistics so far. Auto sales in China increased 9.1% year over year to 7,925,100 units in the first 4 months of 2014.
To tap the growing Chinese market, Ford plans to triple its line-up in the nation by introducing 15 new or revamped vehicles by 2015. The popularity of Ford's expanded product line-up in China boosted the automaker's sales by 49% in 2013. The improvement continued in 2014, with a 45% increase in sales to 271,321 vehicles in the first quarter. Ford expects Asia-Pacific (mainly China and India) to account for 70% of its global growth in this decade and generate 40% of its vehicle sales in the coming 4 to 5 years.
The company expects its global sales to increase 50% to 8 million vehicles by 2015 on the back of the growth potential in Asia and the rising demand for small cars. The automaker anticipates small cars to account for 55% of the total sales by 2020. One-third of the small car sales are expected to come from Asia. Ford projects compact car sales in India to reach about 2 million vehicles in 2018, almost double of the 2013 level. In order to support the increasing sales, Ford aims to increase its dealerships in India to 500 by 2015 and in China to 680 by 2016.
Meanwhile, General Motors and its joint venture partners in China plan to invest $12 billion in the country by 2017. The company also plans to launch about 17 new or upgraded car models as part of a major expansion program. In 2012, General Motors built two plants in China to increase production capacity by 20%. With the planned addition of four new plants, production capacity will increase further by 30% to 5 million vehicles whereas vehicle exports are expected to triple to 300,000 units by 2015. General Motors also projects production capacity growth of 65% by 2020 in China, which is its largest market.
Even Tesla Motors, Inc. (NASDAQ:TSLA) is seeking a share in the lucrative Chinese market. It started delivering the Model S in China in April. The electric carmaker plans to open 10 to 12 stores in the country by the end of 2014, including its flagship store in Beijing which was opened in Nov 2013. Tesla expects China to account for 30-35% of its global sales growth in 2014. The company is planning to start manufacturing cars in China in the next 3 to 4 years. The high import tariff charged on vehicles sold in the nation can be avoided once local production commences. This will slash vehicle prices in the nation, and will likely boost sales.
In 2009, China overtook the U.S. as the biggest auto market in the world with respect to sales volumes when the Beijing government introduced a stimulus package, including tax incentives for small cars. 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 only 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 recorded a 13.9% surge in vehicle sales to 21.98 million units in 2013. However, sales growth is expected to slow down to 8-10% in 2014 per CAAM. Efforts to control pollution and traffic congestion, along with caps imposed by several cities to limit new vehicle registrations are expected to affect sales.
However, following the recent ruling by the World Trade Organization that the duties imposed by China on cars imported from the U.S. violate global trade rules, China will likely have to remove these duties. This will significantly reduce the cost of imported cars in the nation, which will likely boost sales.
Repayment of Bailout Funds
General Motors and Chrysler received $62 billion from the U.S. government under the Troubled Assets Relief Program (TARP). The U.S. Department of Treasury incurred a loss of $2.9 billion on its $12.5 billion loan to Chrysler.
Meanwhile, the Department recovered a total of $39 billion out of its bailout loan of $49.5 billion to General Motors following its bankruptcy, thus incurring a loss of $10.5 billion. Another $826 million was lost due to write-off of administrative claims against the company, taking the total loss to $11.2 billion.
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 2013, 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 issue 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 a supplier network in these unfamiliar regions remains one of their greatest challenges. Existing suppliers to automakers often lack the financial strength to expand capacity in new markets. On the other hand, technology transfers to local third parties can give rise to low-cost competitors for auto parts suppliers.
Moreover, high dependence on automakers makes auto market suppliers vulnerable to pricing pressures and production cuts. Pricing pressure from automakers constricts margins of parts suppliers. Simultaneously, production cuts by automakers, driven by frequent market adjustments, negatively affect their operations.
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. (NASDAQ:GT), Magna International Inc. (NYSE:MGA), Superior Industries International Inc. (NYSE:SUP), Tenneco Inc. (NYSE:TEN) and TRW Automotive Holdings Corp. (NYSE:TRW).
Safety recalls and related costs have become a big problem for many major automakers in recent years. In 2013, automakers recalled 22 million vehicles in 632 recalls. This represents a significant increase from 16.4 vehicles in 581 recalls in 2012.
Currently, General Motors is facing a hard time due to safety issues in its cars. Recently, the automaker agreed to pay a fine of $35 million to the U.S. safety regulators for the late recall of 2.6 million cars. Currently, this is the maximum amount the government can fine a company. General Motors is facing many lawsuits and investigations related to the issue, which also resulted in negative publicity.
In the wake of the problems faced due to this delayed recall, the company has become extra cautious and has announced a series of recalls to avoid further problems. General Motors has recalled more than 13.6 million vehicles in 31 recalls so far this year. The automaker estimates that it will incur a charge of about $400 million in the second quarter for repairing all the vehicles recalled during this quarter. The company recorded a $1.3 billion charge for recall-related repairs in the first quarter.
Another big victim of this problem is Toyota, which recalled the most amount of vehicles in both 2012 and 2013 - about 5.3 million vehicles in each of these years. Meanwhile, Chrysler led in terms of number of recalls, with a total of 36 recalls announced in 2013.
Automotive safety recalls were brought into focus by the media after Toyota's announcement of the then-largest global recall of 3.8 million vehicles in Sep 2009, which was 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 regarding a defect in its vehicles to safety regulators and a delay in recalling the defective vehicles. According to safety regulators, it was the maximum allowable fine at that time for not initiating a timely recall. Toyota also paid a fine of roughly $48.4 million to the U.S. government in 2010 due to a late recall of millions of defective vehicles. Toyota also made one of the largest settlements in the history of automotive industry, paying $1.6 billion in a class-action lawsuit related to complaints of unintended acceleration in its vehicles.
In Mar 2014, Toyota agreed to pay $1.2 billion to the U.S. Attorney's Office for the Southern District of New York in relation to the criminal charges for problems in accelerator pedals and floor mats of its cars, which led to sudden acceleration and even crashes. This is the highest penalty imposed on any automaker.
Moreover, in Apr 2014, Toyota announced its second largest recall of 6.36 million vehicles globally. 27 Toyota models were recalled for 5 different issues and some of the cars were recalled for multiple issues. If we double count such vehicles, the total number of recall increases to 6.76 million. Apart from these, Toyota has announced many other comparatively smaller recalls, including one for 1.9 million third-generation Prius cars in Feb 2014.
Following Toyota, recalls by other automakers such as Chrysler, Ford, General Motors, Honda, Volkswagen and Nissan grabbed people's attention. Volkswagen's recall of 2.64 million vehicles in Nov 2013 is also among the larger global recalls.
Slow Recovery in Europe
While the automobile market in Europe has started recuperating in the last few months, sales remain low. A large part of the increase in auto sales in recent months can be attributed to high discounts offered by automakers. While Europe has begun recovering from the sovereign debt crisis, employment levels and consumer confidence continue to remain weak and economic growth has not stabilized yet.
Unemployment rate in the European Union declined marginally to 10.5% in Mar 2014 from 10.9% in Mar 2013, according to Eurostat. About 25.7 million people were unemployed during the month, of which 18.9 million people were located in the Euro area. The seasonally adjusted unemployment rate in the European Union was 10.5% in Mar 2014 compared with 10.9% in Mar 2013, while it decreased to 11.8% in the Euro area from 12% in Mar 2013.
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. Most of the major automakers in Europe resorted to job cuts and plant closures, as it was no longer feasible for them to carry on full-fledged operations in the continent.
General Motors is suffering from significant losses in its European business segment and hopes to achieve breakeven level next year. Ford's European operations also continue to incur losses, although the amount of loss has started reducing and the company expects to earn profits in 2015.
According to the European Automobile Manufacturer's Association (ACEA), car sales in the European Union reached 11.85 million units in 2013, down 1.7% over 2012 and its lowest level since 1995. However, in the first four months of 2014, passenger car sales increased 7.4% to 4.3 million units in the region.
With the recent improvement in the European economy, things are beginning to look up for automakers. Car sales in Europe are expected to rise gradually, although the process is expected to be slow. Car sales in Europe are expected to increase 2-3% in 2014.
Low Popularity of Green Cars
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. However, despite the U.S. government's continued efforts to promote green alternatives such as fuel-efficient electric vehicles (EVs) and hybrid vehicles, prospects for the environment-friendly cars look bleak, at least in the near future. High car prices and improving fuel economy of non-hybrid cars are some factors that are hurting the sales of hybrids and EVs.
Globally, the hybrid market is ruled by Toyota (which includes Prius, Avalon, Camry and Highlander) and Honda (including 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.
The 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 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 vehicle sales constituted less than 1% of total passenger vehicle sales in the U.S. in 2013. The proportion declined from 3.3% 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. It also led to writing down of the value of the third largest DOE grant recipient, Dow Kokam, by chemical behemoth Dow Chemical (NYSE:DOW), which jointly operates the entity with TK Advanced Battery LLC since 2009.
Labor Union Woes
Frequent demands for wage hikes and strikes by labor unions are concerns for automakers. The 4-week strike toward the end of 2013 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).
This was followed by a labor strike in the auto components industry, which also lasted for four weeks. These strikes have forced car makers to rethink their investment strategies for the nation. In Oct 2013, 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. Labor strikes in Jul 2013 resulted in production losses of over $90 million, forcing the company to reach a wage settlement. In Mar 2014, Toyota had to stop production for a few days in two of its Indian assembly plants as demands for wage hike led to disrupted production and labor unrest.
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