The global automotive market continues to grow but demand in key markets is easing. A modest global economic outlook for 2018 and 2019 along with robust demand in some emerging markets in Asia has kept hopes alive for the industry amid growing trade tensions.
Foreign automakers play a key role in the U.S. auto space. In fact, vehicles that are imported and those built by foreign manufacturers in the United States have a huge impact on the automotive industry. In fact, automakers from Japan, Germany, China, South Korea and France have made the U.S. auto market all the more competitive. Currently, foreign automakers are eyeing areas where incentives (like less unionized labor) are more. Per a Wall Street Journal report, foreign auto companies will soon build more cars and trucks in the United States than the Detroit giants.
However, all automakers are troubled by higher steel and aluminum prices and strict emissions regulations in China and Europe. Also, the uncertainty surrounding U.S. trade policies is putting pressure on the profits of auto companies.
Again, with the new North American Free Trade Agreement (NAFTA), Trump is forcing companies to abandon cross-border supply chain in favor of more expensive and onerous domestic production. The result is higher prices for consumers and a less competitive automotive industry in North America. Foreign automakers rely on Mexico not only for its access to the U.S. market but also its cheap labor. Importantly, Mexico has free trade agreements with several other countries and has a large access to the global auto market. Many foreign auto companies are using Mexico as an export gateway to Asia and Europe.
Industry Comparison with S&P 500, Sector
Broader economic growth has not been enough to give market participants confidence in the industry's outlook. The uncertainty pertaining to trade acted as a tailwind and shareholder returns of the group comprising foreign automakers lagged the return generated by the Zacks S&P 500 Composite.
The Automotive – Foreign industry, which is an eighteen-stock group within the broader broader Zacks Auto, Tires And Trucks Sector that includes companies like Toyota Motor Corporation (TM - Free Report) and Volkswagen AG (VLKAY - Free Report) , has outperformed its own sector while underperforming the S&P 500 over the past year.
While the stocks in this industry have collectively edged up 0.2%, the Zacks S&P 500 Composite grew 17.7%. The Zacks Auto, Tires And Trucks Sector has however declined 1.9% in the same time frame.
One-Year Price Performance
Foreign Automotives Trading Cheap
We can look at a variety of valuation metrics to evaluate the industry’s valuation picture and all of those will likely help us reach the same conclusion. But given the high capital intensity of the space, the appropriate metric is the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio or multiple. This metric takes into consideration equity as well as the level of debt. Also, this metric is not impacted by differing capital structures and does not take into account the effect of non-cash expenses.
Owing to the industry’s underperformance over the past year, the valuation appears attractive in comparison to the S&P 500. The industry currently has a trailing 12-month EV/EBITDA ratio of 7.2, at a discount to the S&P 500’s EV/EBITDA ratio 11.9. As the chart below shows, the S&P 500 index has traded as high as 12.7X and as low as 10.7X, with a 12-month median of 11.5X.
Enterprise Value/EBITDA TTM
Again, a comparison of the Zacks Auto, Tires And Trucks Sector with that of Automotive – Foreign industry indicates that the group trading at a discount. The Zacks Auto, Tires And Trucks Sector’s trailing 12-month EV/EBITDA ratio of 8.6 and the median level of 8.7 for the same period is above the Zacks Automotive – Foreign industry’s respective ratios.
Enterprise Value/EBITDA TTM
Price Performance May Improve Due to Better Earnings Outlook
Despite the growing trade tensions, modest demand from emerging nations has been aiding Foreign Automotive industry players.
The industry’s recent stock market performance notwithstanding, the more relevant question for investors is how the industry will perform going ahead.
A good handle on the industry’s and companies’ evolving earnings outlook can help answer that question for us. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry below shows the market’s evolving bottom-up earnings expectations for the industry and the industry’s aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Foreign Automobiles Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $5.26 EPS estimate for 2018 is not the actual bottom-up EPS estimate for every company in the Zacks Foreign Automotive industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the gain of $5.26 per share of the industry for 2018, but how this estimate has evolved recently.
The consensus estimate for the Zacks Foreign Automotive industry of $5.26 per share implies not only a year-over-year improvement but also a favorable trend in earnings estimate revisions lately.
Looking at the aggregate earnings estimate revisions, it appears that analysts are bullish on this group’s earnings potential.
The consensus EPS estimate for the current fiscal year has been revised 1.3% upward since July 2018.
Current Fiscal Year EPS Estimate Revisions
Zacks Industry Rank Indicates Cloudy Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates the possibility of underperformance in the near term.
The Zacks Foreign Automotive industry currently carries a Zacks Industry Rank #184, which places it at the bottom 28% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has been in the bottom 50% in the past seven weeks.
Foreign Automotives Promise Stable Growth
While the near-term prospects appear not much encouraging for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Foreign Automotive industry appears stable. In the past year, long-term EPS growth of the Zacks Foreign Automotive industry has remained higher than that of the Zacks S&P 500 Composite. In the last few months, the long-term EPS growth estimate for the industry has been flat though above the EPS growth estimate of Zacks S&P 500 Composite.
The revenue growth trend since 2015 is pretty steady. In fact, the revenue growth rate is showing an upward trend over the past three years.
Mean Estimate of Long-Term EPS Growth Rate
A closer look at the foreign auto industry brings forward some interesting facts. Cheap valuation and improving EPS estimate revisions, growing revenue growth indicate some distinct bright spots. Moreover, these fundamental factors are further bolstered by strong demand from the emerging markets.
However, the industry is also undergoing changes and faces its share of challenges. The growing trade tensions and the need to adapt to changing environment due to transition towards electric vehicles and autonomous future will keep automakers on tenterhooks.
While none of the stocks in our foreign automobiles universe currently sport a Zacks Rank #1 (Strong Buy), below we highlight two stocks that have been witnessing positive earnings estimate revisions and carry a Zacks Rank #2 (Buy).
(You can see the complete list of today’s Zacks #1 Rank stocks here.)
CNH Industrial N.V. (CNHI - Free Report) : The stock of this London, United Kingdom-based automobile company has gained 5.9% over the past year. The Zacks Consensus Estimate for current-year EPS was revised 5.7% upward over the last 60 days.
Price and Consensus: CNHI
Honda Motor Co., Ltd. (HMC - Free Report) : The stock of this Tokyo, Japan-based auto manufacturer has gained 5% over the past year. The Zacks Consensus Estimate for the current-year EPS was revised 2.3% upward over the last 60 days.
Price and Consensus: HMC
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