Are the wheels falling off the autos sector?
Are the wheels falling off the autos sector?
The autos sector has experienced a severe de-rating over the last year as investors believe earnings are at a cyclical, and possibly structural, peak. We agree that consensus expectations for auto manufacturers in aggregate are overly optimistic, though earnings for some companies will move higher due to geographic exposure and share shifts.
In this paper, we explore the outlook for earnings growth for the sector. For OEMs1, we focus on top-line growth prospects by geography, cost structures, and drivers of potential market share shifts. For suppliers, we address the debate over the degree to which industry value-add has shifted from OEMs to suppliers, and the potential for sustainably higher growth.
Overall, we expect volumes to rise over the next few years, barring a broader economic downturn, but the value of global auto sales to be flat-to-down due to price and mix pressure. Combined with structural cost inflation, this is likely to erode industry profitability. Despite cheap headline valuations, we do not believe most auto stocks are attractively priced on mid-cycle earnings, and see further downside risk to the sector. However, we are beginning to see value emerging in some cases, especially for companies with a better track record of delivering in a downturn.
European carmakers are best placed
- We are most optimistic on the outlook for Europe, where volumes are lower relative to pre-crisis levels and improving utilisation should support better pricing. This leads to a preference for European over US and Japanese carmakers. Contrary to popular perception, we believe European manufacturers’ profits are driven more by their domestic market than by China.
- Profitability in China is still high versus global averages, with most joint ventures making double-digit operating margins. However, we would expect margins to remain under pressure as excess capacity depresses pricing, labour and content costs creep up towards developed world levels, and mix deteriorates with more sales to lower-tier cities and rural areas.
- There are other emerging markets with huge growth potential relative to their current size (India and Indonesia in particular), but volumes over the next few years will not be big enough to move the needle for global OEMs, and average transaction prices are much lower.
Preference for suppliers over manufacturers
- We still prefer suppliers to auto manufacturers.
- We agree with the consensus view that suppliers can continue to grow profits in a low volume growth environment due to consolidation, outsourcing, and control of intellectual property. Among supplier stocks, we prefer companies with exposure to products where pricing power and growth should be more resilient, such as mild-hybrid systems and ADAS (advanced driver assistance systems). We look for best-in-class operators, with a proven track record of content-per-vehicle growth and solid order books.
- The biggest near-term risk to our more bullish thesis on suppliers it that demand for higher content per vehicle begins to decline sooner due to tighter financing. This is a bigger risk to suppliers of “discretionary” content (infotainment, interiors etc.) than to suppliers of “regulated” content (emissions, safety).
- However, supplier valuations are more demanding than for OEMs and the stocks look efficiently valued on a mid-cycle view.
Tyremakers are mispriced
- Tyres are more attractive and we don’t believe they should trade at a discount to the group at this point in the cycle.
- Given replacement patterns, tyre volume growth is driven by vehicle sales 3-4 years ago, implying the last few years of robust industry growth will represent a tailwind for tyres even as the front-book slows. Volumes will be more defensive in a downturn as there is a limit to how long replacements can be deferred.
- The premium tyremakers also have a remarkable track record for pricing discipline, meaning we do not worry much about raw material trends.
1. Original equipment manufacturers, confusingly used as industry shorthand for carmakers rather than auto parts suppliers. ↩
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