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Auto Sector Grapples with Peak U.S. Sales, Safety Recalls

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The auto industry has been enjoying very strong sales trends lately, but further upside from the lofty levels of 2017 appears hard to come by. The industry is also faced with the challenge of profitably manufacturing electric vehicles.

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

EV Race, with No Hint of Profit

In an effort to respond to stringent emission standards and the proposals made by some Asian and European countries to prohibit internal combustion engines driven by fossil fuels, many traditional automakers across the globe have geared up for electric vehicles. However, the new technology is yet to yield profits — the key to the survival of any business entity

Presently, EVs account for less than 1% of U.S. vehicles sales and a small part of total vehicles sold across the globe. EV pioneer Tesla, Inc. (TSLA - Free Report) is losing money persistently.

Despite these odds, traditional automakers are investing huge amount of money to brace for an all-electric future. These companies are using profits generated from the sale of gasoline-fueled trucks and sport utility vehicles to invest in the expensive EV technology.

Safety Recall Expenses

One serious problem automakers across the globe are facing is huge expenses related to safety recalls. According to the data provided by the U.S. Transportation Department, automakers recalled 53.2 million vehicles in the United States in 2016, setting a new record.

It is expected that in 2017, the recall figures will be very high due to defective Takata airbag inflators, which caused significant number of recalls between 2014 and 2016.

Many auto giants such as General Motors Company (GM - Free Report) , Ford Motor Company (F - Free Report) , Honda Motor Co., Ltd. (HMC - Free Report) and Volkswagen AG VLKAY have been facing recall issues in recent times.

U.S. Sales Set to Dip

Following two years of record volumes, most analysts believe that U.S. auto sales have likely declined in 2017 (we will get final December numbers in the next couple of weeks). This will be the first full-year sales decline since the recession. Per the projection given by PricewaterhouseCoopers, auto sales are likely to reach 17.1 million in 2017, down from 17.6 million in 2016. The National Automobile Dealers Association projected 2018 sales of 16.7 million vehicles.

In fact, constrained demand during the recession period, which saw sales picking up in the last few years, seems to have got absorbed now. Sales have been falling as buyers have become more unpredictable 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 created strong demand amid low gas prices.

Declining Used Car Prices

According to the Moody’s report, prices of used cars are declining in the United States, as millions of leases are nearing expiry date. This is not bad news for the customers but definitely not for automakers and dealers. In fact, low prices of used vehicles compel automakers to offer higher discounts to customers on new vehicles, which in turn put strain on their margins.

Rising Delinquency Rates

According to Moody’s, huge competition among banks, finance companies and credit unions have resulted in loosening of the underwriting conditions. Presently, loan terms in the United States are more than six months longer than they were in 2010. Also, lenders are being allowed the facility to roll a significant part of the unpaid balance into new loans. This is leading to rising delinquency and its long-term effect can be serious.

Market Share Concentration

The majority share of the automobile market is held only by a few leading automakers. 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 in order 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 Tesla, Inc. (TSLA - Free Report) , Superior Industries International, Inc. (SUP - Free Report) and Continental AG (CTTAY - Free Report) .

Meanwhile, investors who continue to be optimistic about the sector can check out companies like Allison Transmission Holdings, Inc. ALSN, AB Volvo (VLVLY - Free Report) and Wabco Holdings Inc. (WBC - Free Report) . While Allison Transmission and Volvo sport a Zacks Rank #1 (Strong Buy), Wabco Holdings carries a Zacks Rank #2 (Buy).You can see the complete list of today’s Zacks #1 Rank stocks here.

Allison Transmission has a long-term growth rate of 10%. Shares of the company have gained 22.5% year to date.

Volvo has a long-term growth rate of 15%. Shares of the company have gained 59.3% on a year-to-date basis.

Wabco Holdings has a long-term growth rate of 15%. Its shares have rallied 32.3% year to date.

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