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Auto Industry Stock Outlook: Can Sales Pull Up Earnings?

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The last two years have been exceptional for the auto sector. Sales in the U.S. saw record highs in both years, while sales in China and Europe also gained strength.

According to IHS Automotive, global auto sales figures for 2016 are expected to be close to 90 million units. Moreover, margins of automakers are benefiting from an increase in sales of higher margin vehicle segments, such as SUVs and light trucks, due to low fuel prices.

On the other hand, automakers bore the brunt of expenses related to safety recalls and negative currency effects. Massive recalls related to Volkswagen AG’s emission scandal, General Motors Co.’s (GM - Free Report) ignition switch defect and Takata Corp’s defective airbag inflators have been hurting the auto sector in recent years.

Despite the emission scandal, Volkswagen managed to become the highest selling automaker in the first nine months of 2016. With sales of 7.6 million units, it edged past Toyota Motor Corp. (TM - Free Report) , which sold 7.5 million vehicles globally. Toyota had reigned as the leading automaker for four years in a row. With sales of 7.2 million vehicles, General Motors ranked third in the first nine months of 2016.

Zacks Industry Rank – Mixed 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, wherein autos are part of the Consumer Discretionary sector. The S&P has 10 sectors compared with the 16 sectors 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 sector’s retail operations are part of the Zacks Retail sector in two industries: Auto/Trucks and Other Auto Parts. The level of sensitivity and exposure to the different stages of the economic cycle vary for each industry.

The current Zacks Industry Rank is #84 for Automotive - Domestic, #51 for Automotive - Foreign, #203 for Automotive - Original Equipment, #187 for Automotive - Replacement Parts, #187 for Automotive - Internal Combustion Engines, #21 for Automotive - Retail and Whole Sales and #52 for Automotive - Retail and Wholesale - Parts. As a reference point, the outlook for industries with a 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 outlook for auto-related industries is mixed. 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.

Sector Level Earnings Trend

The auto sector is expected to contribute 2.0% to the total S&P 500 earnings in 2016. This is nearly double its 1.1% market cap weight in the index at present.

Looking at the overall results of the auto sector, earnings surged 16.2% in the second quarter of 2016 but declined 8.2% in the third quarter. Auto sector earnings are expected to fall 21.3% in the fourth quarter of 2016 and 13.6% in the first quarter of 2017, placing the sector among the laggards.

Total revenue increased 5.8% year over year in the second quarter of 2016 but fell 1.1% in the third quarter. Revenues are expected to move up 0.3% in the fourth quarter of 2016 and down 1% in the first quarter of 2017.

Despite the weak outlook for the upcoming quarters, earnings for 2016 are expected to rise 1.2% over 2015. Also, revenues for the year are expected to go up 0.7%.

For more information on earnings for this sector and others, please read our latest 'Earnings Trends' report.

Bottom Line

The auto sector is currently facing several opportunities as well as challenges. While low fuel prices, attractive financing options and impressive vehicle launches are driving vehicle sales, headwinds include slowing sales growth in the U.S., the negative impact of currency translation and high levels of safety recalls.

Nevertheless, the outlook for global vehicle sales for 2016 remains strong with the projection of nearly 90 million vehicles by IHS Automotive. At this juncture, we recommend 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%.

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