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Auto Sector Challenged by High Safety Recalls, Slower U.S. Sales
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Strong sales volumes in all major markets have been a boon for the auto sector lately. However, there are many challenges being faced by automakers as well. Chief among these are the high expenses related to auto recalls. Sales growth in the U.S. and Europe is also slackening.
While there are several positives such as low gas prices, record U.S. sales and impressive China sales, there are also plenty of reasons to be careful about the auto industry in both the short and the long term. Below, we discuss some of the key challenges that investors in the auto sector should watch out for in the coming months and years.
HighCost of Safety Recalls
Safety recalls and related costs have turned out to be major issues for most automakers. Per the National Highway Traffic Safety Administration (NHTSA), automakers recalled 51.26 million vehicles in the U.S. in 2015, setting a new record. In total, automakers announced nearly 900 recalls for safety issues in 2015, also a new record.
The previous record for both the number of recalls and the number of vehicles recalled was set in 2014, when automakers announced 803 recalls covering 50.99 million vehicles. Notably, these figures only cover the recalls in the U.S. and the global recall numbers are much higher.
Auto recall figures for 2016 are also expected to be high due to defective Takata airbag inflators, which resulted in significant recalls in 2014 and 2015, as well. Per Consumer Reports, the number of vehicles that need to be recalled by 2019 for defective Takata airbag inflators is over 100 million globally. It is the largest auto recall in the U.S.
Volkswagen AG’s emission scandal is also responsible for a significant number of recalls, although these are not included in the figures given by the NHTSA as this is a standards’ violation and not a safety issue. Recently, the EPA also accused Fiat Chrysler (FCAU) of using software to manipulate emissions in vehicles that would have otherwise violated the Clean Air Act. This may again lead to a large number of recalls.
Strict implementation by the government and high fines imposed in recent years on many automakers for delay in reporting safety issues prompted many companies to proactively announce safety recalls. Recall-related repair costs increase the financial burden of auto manufacturers. A massive recall can also hurt sales volumes, as consumers question brand safety.
U.S.Sales Set to Plateau
Following two years of record volumes, most analysts believe that U.S. auto sales are reaching a plateau. Sales are expected to be significantly high this year, but lower than 2016.
Pent-up demand from the recession period, which drove sales in the last few years, seems to have nearly satisfied. Moreover, with several rate hikes planned by the Fed, interest rate on auto loans may also rise. This will have a direct impact on sales volume.
Risk of Border Tax
President-elect Donald Trump is planning to impose taxes as high as 35% on imports of Mexico-made vehicles. While the policy is aimed at encouraging production in the U.S., most automakers have been producing a significant proportion of their vehicles in Mexico for a long time to take advantage of lower costs. This allows them to reduce the cost of production, which ensures profitability of the low margin vehicle segments. A hefty border tax may force these automakers to reduce or completely stop production in Mexico, which can affect their bottom lines.
Slower Sales Growth in Europe
Although the European auto market is recovering, it is expected to witness slower growth this year. Per the European Automobile Manufacturer’s Association, passenger car sales are expected to increase only 5% in 2016 compared with 9.3% growth recorded in 2015.
Market Share Concentration
The majority share of the automobile market is held only by a few leading automakers. This makes the automobile sector highly competitive. The top 10 global automakers account for nearly 81% of total vehicles sold, according to marketrealist.com.
Moreover, high dependence on these automakers makes auto parts’ suppliers vulnerable to pricing pressure and production cut. Pricing pressure from automakers constricts margins of parts suppliers. Simultaneously, frequent production cuts by automakers to cope with market adjustments affect suppliers’ operations.
The auto industry continues to face a number of challenges, despite the positives. As a result, we would advise staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as Volkswagen, Meritor and Unique Fabricating, Inc. .
Meanwhile, investors who continue to be optimistic about the sector can check out stocks such as Penske Automotive Group, Inc. (PAG - Free Report) , Fox Factory Holding Corp (FOXF - Free Report) and GKN plc .
Penske Automotive has an expected long term earnings per share growth rate of 8.2%. It recorded average earnings beat of 2.1% over the last four quarters. Penske Automotive carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Fox Factory carries a Zacks Rank #1. The company has an expected earnings growth rate of around 16.6% for the long term. Fox Factory posted positive average surprise of 13.8% over the last four quarters.
GKN holds a Zacks Rank #2 (Buy) and has a long-term growth rate of 6.3%.
Check out our latest Auto Industry Outlook here for more on the current state of this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
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Auto Sector Challenged by High Safety Recalls, Slower U.S. Sales
Strong sales volumes in all major markets have been a boon for the auto sector lately. However, there are many challenges being faced by automakers as well. Chief among these are the high expenses related to auto recalls. Sales growth in the U.S. and Europe is also slackening.
While there are several positives such as low gas prices, record U.S. sales and impressive China sales, there are also plenty of reasons to be careful about the auto industry in both the short and the long term. Below, we discuss some of the key challenges that investors in the auto sector should watch out for in the coming months and years.
HighCost of Safety Recalls
Safety recalls and related costs have turned out to be major issues for most automakers. Per the National Highway Traffic Safety Administration (NHTSA), automakers recalled 51.26 million vehicles in the U.S. in 2015, setting a new record. In total, automakers announced nearly 900 recalls for safety issues in 2015, also a new record.
The previous record for both the number of recalls and the number of vehicles recalled was set in 2014, when automakers announced 803 recalls covering 50.99 million vehicles. Notably, these figures only cover the recalls in the U.S. and the global recall numbers are much higher.
Auto recall figures for 2016 are also expected to be high due to defective Takata airbag inflators, which resulted in significant recalls in 2014 and 2015, as well. Per Consumer Reports, the number of vehicles that need to be recalled by 2019 for defective Takata airbag inflators is over 100 million globally. It is the largest auto recall in the U.S.
Volkswagen AG’s emission scandal is also responsible for a significant number of recalls, although these are not included in the figures given by the NHTSA as this is a standards’ violation and not a safety issue. Recently, the EPA also accused Fiat Chrysler (FCAU) of using software to manipulate emissions in vehicles that would have otherwise violated the Clean Air Act. This may again lead to a large number of recalls.
Strict implementation by the government and high fines imposed in recent years on many automakers for delay in reporting safety issues prompted many companies to proactively announce safety recalls. Recall-related repair costs increase the financial burden of auto manufacturers. A massive recall can also hurt sales volumes, as consumers question brand safety.
U.S.Sales Set to Plateau
Following two years of record volumes, most analysts believe that U.S. auto sales are reaching a plateau. Sales are expected to be significantly high this year, but lower than 2016.
Pent-up demand from the recession period, which drove sales in the last few years, seems to have nearly satisfied. Moreover, with several rate hikes planned by the Fed, interest rate on auto loans may also rise. This will have a direct impact on sales volume.
Risk of Border Tax
President-elect Donald Trump is planning to impose taxes as high as 35% on imports of Mexico-made vehicles. While the policy is aimed at encouraging production in the U.S., most automakers have been producing a significant proportion of their vehicles in Mexico for a long time to take advantage of lower costs. This allows them to reduce the cost of production, which ensures profitability of the low margin vehicle segments. A hefty border tax may force these automakers to reduce or completely stop production in Mexico, which can affect their bottom lines.
Slower Sales Growth in Europe
Although the European auto market is recovering, it is expected to witness slower growth this year. Per the European Automobile Manufacturer’s Association, passenger car sales are expected to increase only 5% in 2016 compared with 9.3% growth recorded in 2015.
Market Share Concentration
The majority share of the automobile market is held only by a few leading automakers. This makes the automobile sector highly competitive. The top 10 global automakers account for nearly 81% of total vehicles sold, according to marketrealist.com.
Moreover, high dependence on these automakers makes auto parts’ suppliers vulnerable to pricing pressure and production cut. Pricing pressure from automakers constricts margins of parts suppliers. Simultaneously, frequent production cuts by automakers to cope with market adjustments affect suppliers’ operations.
Some auto industry suppliers that are dependent on a few major automakers are Meritor Inc. , Tenneco Inc. and Magna International Inc. (MGA - Free Report) . The full list can be seen in this auto supplier page: https://www.zacks.com/stocks/industry-rank/auto-truck-orig-10
Bottom Line
The auto industry continues to face a number of challenges, despite the positives. As a result, we would advise staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as Volkswagen, Meritor and Unique Fabricating, Inc. .
Meanwhile, investors who continue to be optimistic about the sector can check out stocks such as Penske Automotive Group, Inc. (PAG - Free Report) , Fox Factory Holding Corp (FOXF - Free Report) and GKN plc .
Penske Automotive has an expected long term earnings per share growth rate of 8.2%. It recorded average earnings beat of 2.1% over the last four quarters. Penske Automotive carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Fox Factory carries a Zacks Rank #1. The company has an expected earnings growth rate of around 16.6% for the long term. Fox Factory posted positive average surprise of 13.8% over the last four quarters.
GKN holds a Zacks Rank #2 (Buy) and has a long-term growth rate of 6.3%.
Check out our latest Auto Industry Outlook here for more on the current state of this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
Zacks' Top 10 Stocks for 2017
In addition to the stocks discussed above, would you like to know about our 10 finest buy-and-hold tickers for the entirety of 2017?
Who wouldn't? As of early December, the 2016 Top 10 produced 5 double-digit winners including oil and natural gas giant Pioneer Natural Resources which racked up a stellar +50% gain. The new list is painstakingly hand-picked from 4,400 companies covered by the Zacks Rank. Be among the very first to see it>>