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Autos Hit Safety Recalls, Commodity Woes, Used-Car Demand

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Albeit the recent rise in sales, the auto industry is grappling with a myriad challenges. Trade tensions between China and the United States, shifting preference pattern of the consumers, the compulsion to embrace various changes, and safety recall issues are some of the challenges faced by automakers.

In fact, the industry is going through a transition. The necessity of manufacturing electric vehicles in a profitable way is fast becoming a big challenge for automakers.

In fact, there are a number of factors that raise concerns 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.

Safety Recall Expenses

One serious problem automakers across the globe are facing is huge expenses pertaining 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. According to a report by Center for Auto Safety, there about 60 million vehicles on the road that are open to recalls and in need of repairs.

Many auto giants such as Tesla, Inc. (TSLA - 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 and incurring huge expenses in this regard.

EV Race, the New Compulsion

In an effort to respond tostrict emission standards and the proposals made by some Asian and European countries to restrict internal combustion engines driven by fossil fuels, many traditional automakers across the globe have geared up for electric vehicles. However, the new technology has yet to yield profits, which holds 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 is losing money persistently.

Despite these odds, conventional automakers are pouring in a huge amount of money to brace for an all-electric future. These companies are diverting profits generated from the sale of gasoline-fueled trucks and SUVs to invest in the expensive EV technology.

Price Stability & High Demand for Used Cars

A lucratively priced, high-quality used vehicles inventory has prompted consumers to think over the alternatives to buying new cars. This resulted in higher demand for used vehicles. In fact, a leading rating agency Moody’s has projected that the used car and truck Consumer Price Index will suffer a year-over-year decline of 1.07% in 2019, whereas the decline was 3.63% in 2017. The rating agency further anticipates prices to stabilize in 2020.

The price stability of used cars is not bad news for customers but definitely not good news 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 strain their margins.

Moreover, per a research report by Technavio, the increased use of dedicated online sites to sell used cars is having a positive impact on the used-car market. The presence of several online car sales sites has enabled buyers to pick a used car through online sites.

Commodity Woes

President Trump has imposed tariffs on two key commodities: steel and aluminum. However, any increase — tariff induced or otherwise — in the prices of these two important metals that the automobile space is crucially dependent on, will leave an adverse impact. In other words, U.S. automotive companies would lose their competitive capabilities to global rivals if tariffs are imposed on steel and aluminum.

Rising Delinquency Rates

According to Moody’s, huge competition in banks, finance companies and credit unions have resulted in loosening of the underwriting conditions. Presently, loan terms in the United States are 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) .

Lack of Demand for Greener Vehicles

One distinctive feature of vehicles sales is that the sales of vehicles with lower efficiency have been strong in recent times. This indicates lack of demand for greener cars which is actually favored by policymakers across the globe. In fact, in recent times, sales of trucks and SUV, which are usually less fuel-efficient than passenger cars, have been on the rise.

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) and Autobytel Inc. (AUTO - Free Report) . Meanwhile, investors who continue to be optimistic about the sector can check out companies such as PACCAR Inc. (PCAR - Free Report) , Allison Transmission Holdings, Inc. (ALSN - Free Report) and Honda Motor Co., Ltd. (HMC - Free Report) , each carrying a Zacks Rank #2 (Buy).

You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

PACCAR has an expected long-term growth rate of 9.8%. In the past year, shares of the company have gained 2.1%.

Allison Transmission has an expected long-term growth rate of 10%. In a year, shares of the company have returned 12.7%.

Honda has an expected long-term growth rate of 4.8%. In a year’s time, shares of the company have returned 18.6%.

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