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Modest sales in emerging markets have been a boon for the auto sector lately. However, there are a few challenges that are being faced by the auto sector. In fact, automakers are witnessing a revolutionary shift in their operations. The velocity at which consumers’ preferences are changing, has promoted many automakers to reconsider their strategies. Added to this is the compulsion of manufacturing electric and “green” cars, which are likely to bring in several changes in the industry.

There are a number of factors that raise concerns for the auto sector in both the short and the long run. Below, we discuss some of the key challenges that the auto sector might face in the coming months.

Safety Recall Expenses

Safety recalls and related costs have turned out to be a major issue for most automakers. Per the U.S. Transportation Department, automakers recalled 53.2 million vehicles in the United States in 2016, setting a new record. In total, automakers announced nearly 927 recalls for safety issues in 2016, which is another record high.

The previous record for both the number of recalls and vehicles recalled was set in 2015, when automakers announced 900 recalls covering 51.1 million vehicles. Notably, these figures only cover the recalls in the United States; the global numbers are a lot higher.

Auto recall figures for 2017 are also expected to be high as a result of the defective Takata airbag inflators, which resulted in significant recalls between 2014 and 2016. The U.S. regulators expect recalls to eventually affect roughly 42 million vehicles in the country, with nearly 70 million Takata airbags. This also marks the largest auto recall in the United States.

Recently, General Motors Company (GM - Free Report) recalled around 800,000 pickup trucks across the globe. The recall includes 2014 models of Chevrolet Silverado 1500, as well as GMC Sierra 1500, which could lead to loss of power steering. Per company reports, the 2014 model trucks can come across as a temporary loss of power steering, majorly during low-speed turning maneuvers. The recall includes approximately 690,000 vehicles from the United States, 80,000 from Canada and approximately, 25,000 from other markets, globally.

Meanwhile, Volkswagen AG’s (VLKAY - Free Report) emission scandal is responsible for a significant number of recalls. Also, EPA accused Fiat Chrysler (FCAU - Free Report) 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 regulatory implementation by the government and high fines imposed in recent years on many automakers for delay in reporting safety issues prompted a number of companies to proactively announce safety recalls. Recall-related repair costs increase the financial burden of auto manufacturers. A massive recall can also hurt sales as consumers start questioning the brand’s safety.

U.S. Sales Set to Plateau

Following two years of record volumes, most analysts believe that U.S. auto sales are likely to plateau in 2017.

Pent-up demand from the recession period, which drove sales in the last few years, seems to have been satisfied. Moreover, with several rate hikes planned by the Fed, interest rates on auto loans might rise.

Vehicle sales in the United States have already been showing weakness throughout the year. Analysts are predicting sales to plateau at around 17 million annually for the foreseeable future after two consecutive years of record results. Sales have been falling as potential buyers have become more erratic despite generous incentives offered on vehicles. Those discounts, which erode profits of automakers, have recently spread to high-margin pickup trucks and SUVs that have garnered strong demand amid low gas prices.

Slower Sales Growth in Europe

Although the European auto market is recovering, it is expected to witness slower growth this year. Per the IHS Markit report, light vehicle sales growth in 2017 is expected to slow down to 1% compared with growth of 6.2% in 2016. Uncertainty related to macro-economic conditions and political developments remain in the region.

Declining Used Car Prices

Used car prices have been declining in the United States. The NADA Used Car Guide’s used car index has been falling consistently over the last few months, with an exception in March. In 2017, prices are expected to decline 6.5% year over year. This expected fall in price is 2.5%, worse than 2016’s price fall of 4%.

This has been supported by a large number of leased cars coming off of the lease, increasing the supply of used cars. A fall in price of used cars will lead to a decline in demand for new cars. Moreover, automakers may need to offer further incentives to boost new car sales.

Alternately, for companies such as CarMax Inc. (KMX - Free Report) -- dealing primarily in used cars -- a decline in average selling price is expected to affect revenues.

Rising Delinquency Rates

Auto loans have been rising consistently over the last few years, touching a record $1.16 trillion in 2016, per the Federal Reserve Bank of New York. While this rise in loans has been driving auto sales, consumers with the riskiest credit profiles saw the highest growth. This has led to a significant rise in auto loan delinquencies. For loan providers, as bad debts increase, the loans provided will also decline, affecting demand for vehicles.

Market Share Concentration

The majority share of the automobile market is held only by a few leading automakers. The top 10 global automakers account for nearly 81% of the 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. (MTOR - Free Report) , Tenneco Inc. (TEN - Free Report) and Magna International Inc. (MGA - Free Report) .

Bottom Line

The auto industry continues to face a number of challenges. As a result, we would advise investors to dump stocks with a Zacks Rank # 4 or 5 such as Harley-Davidson, Inc. (HOG - Free Report) , Tata Motors Ltd. (TTM - Free Report) and Gentherm Inc. (THRM - Free Report) .

Meanwhile, investors who continue to be optimistic about the sector can check out companies like Continental AG CTTAY, PACCAR Inc. (PCAR - Free Report) and Fox Continental Holding Corp. (FOXF - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Continental has a long-term growth rate of 7.9%.

PACCAR has a long-term growth rate of 10%.

Fox Factory has a long-term growth rate of 14%.

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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