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Low fuel costs and improving macroeconomic factors helped the auto sector record impressive volumes in 2016. While sales hit an all-time high in the U.S., China and Europe also reported strong volumes. Meanwhile, low fuel prices led to increased sales of higher margin vehicle segments, such as SUVs and light trucks.

However, the sector is facing certain challenges, the most significant one being massive recall volumes, particularly due to defective Takata airbag inflators and the Volkswagen AG (VLKAY - Free Report) emission scandal. Moreover, sales growth in the U.S. is projected to slow down this year.

Still, there are plenty of reasons to be optimistic about the broader auto industry for both the short and long term. Below, we discuss some of the key factors that should continue to drive the sector’s performance in the near to medium term.

OPPORTUNITIES

Record Sales in the U.S.

U.S.light vehicle sales inched up 0.3% to 17.55 million units in 2016. Although the percentage of increase was low, sales volumes surpassed the all-time record set in 2015. Moreover, 2016 was marked as the seventh consecutive year of increase in sales.

Results were driven by higher employment levels, low fuel prices, easy availability of credit, attractive incentives and economic stability. Product segments like trucks and utility vehicles continued to record strong sales.

Most analysts expect U.S. auto sales to remain strong in 2017, although volumes may be lower than 2016 levels. Strong macroeconomic factors such as rising employment and personal income as well as low fuel prices will continue to drive sales. Moreover, sales of high margin product segments such as pickup trucks, SUVs and crossover vehicles are expected to remain strong this year. Per IHS Markit, total global light vehicle sales in 2017 will touch 93.5 million units, up 1.5% from 2016.

Further, the high average age of cars on U.S. roads should continue to boost replacement demand for cars as well as car parts. The average age increased to 11.6 years in 2016, according to IHS Automotive. Moreover, by 2021, around 81 million vehicles are expected to be over 16 years old compared with 62 million vehicles today.  This will benefit replacement part manufacturers and retailers, apart from new vehicle manufacturers and retailers.

Sales in China Rev Up

Many automakers, including the likes of Ford Motor Co. (F - Free Report) and General Motors Company (GM - Free Report) , have been banking on strong sales growth in China to drive earnings over the next few years. Auto sales in the world’s largest automobile market increased 14.5% year over year to a record 28,119,000 units in 2016. Sales of passenger cars increased 14.9% to almost 24.38 million units, hitting a new record. Moreover, sales of commercial vehicles improved 5.8% year over year.

So far in 2017, both passenger cars and commercial vehicles recorded strong sales in China. Sales of passenger cars increased 4.6% year on year to almost 5.95 million units in the first three months of 2017, while sales of commercial vehicles rose 22.9% to 1.05 million units. Consequently, total automobile sales increased 7% year over year to more than 7 million units.

Sustained Recovery in European Union

New passenger car registrations in the European Union increased 8.4% to over 1.14 million units in the first three months of 2017, as per the European Automobile Manufacturer’s Association. All major markets posted strong growth during the period. Rising consumer confidence, solid incentives, strong replacement demand and product launches are driving sales.

Following six years of decline, sales of passenger cars in the European Union turned around with a 5.7% year-over-year increase in 2014 and another 9.3% increase in 2015. The recovery continued in 2016 with a 6.8% year-over-year increase in passenger car registrations. Sales are expected to improve further this year.

Low Gas Prices

While gasoline prices have been trending higher in recent months, they are significantly below the levels attained in the 2011–2014 period. Low fuel prices are a major tailwind for automakers. As fuel becomes more affordable, sales of gasoline-powered vehicles – especially the larger ones that carry a wider profit margin – get a boost.

Although sales of hybrids and electronic vehicles suffer from this trend, the sales volume is significantly lower than gasoline-powered vehicles. Hence, the positive impact of low gas prices outweighs the negatives for the auto sector.

Attractive, Tech-Savvy Vehicle Launches

Rising sales and intense competition are encouraging automakers to come up with new and attractive, technologically advanced vehicles to gain market share. Most automakers are also revamping their popular vehicles by adding new technologies and enhancing their visual appeal to revive sales. Features such as backup cameras, automatic emergency braking and in-car connectivity are common in most vehicle segments.

In fact, automakers are offering attractive optional features in vehicles to scoop up more profits. These features provide scope for surplus revenue generation from small cars, which have lower profit margins than large trucks.

Bottom Line

The auto industry is benefiting from many factors. According to IHS Automotive, global auto sales figures for 2017 are expected to reach 93.5 million units, up 1.5% over 2016. Volumes are expected to be strong this year as well, driven by sturdy sales in key markets. Moreover, sales in China are expected to grow 1.9% year over year in 2017. This represents a good buying opportunity for investors with longer-term plans.

Some auto sector companies worth considering include Cummins Inc. (CMI - Free Report) , Fox Factory Holding Corp (FOXF - Free Report) and GKN plc (GKNLY - Free Report) .

Cummins has an expected long-term earnings per share growth rate of 9.8%. It recorded an average earnings beat of 14.5% over the last four quarters. Cummins 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 a 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 affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.


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