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Ride the Domestic Auto Industry's Resilience With These 2 Stocks

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Despite concerns over higher borrowing costs, Americans' unwavering love for cars and pent-up demand are boosting the outlook of the Zacks Domestic Auto Industry. The industry is set to benefit from strong consumer demand and improved inventory levels, rising incentives and the surging popularity of electric vehicles (EVs). Capitalizing on favorable market trends, domestic automakers are enjoying robust recovery and growth as they overcome pandemic-related challenges. Investors can ride the industry’s strength with stocks like General Motors (GM - Free Report) and PACCAR (PCAR - Free Report) to fetch handsome gains.

About the Industry

The Zacks Domestic Auto industry includes companies that are engaged in designing, manufacturing and retailing vehicles across the globe. These include passenger cars, crossover vehicles, sport utility vehicles, trucks, vans, motorcycles and electric vehicles. The industry — which is highly consumer cyclic and provides employment to a large number of people — is at the forefront of innovation, courtesy of its nature and the transformation that it is going through. The widespread usage of technology and rapid digitization are resulting in a fundamental restructuring of the automotive market. Several companies in the industry have engine and transmission plants and conduct research and development, and testing of electric and autonomous vehicles.

Key Investing Themes

Demand Remains Strong Despite High Borrowing Costs:  At the outset of 2023, industry experts anticipated a potential deceleration in the U.S. car market amid the increased cost of vehicle financing. However, consumer demand demonstrated greater resilience than anticipated. New vehicle sales in the second quarter of 2023 topped 4 million units, implying year-over-year and sequential growth of roughly 15% and 13%, respectively. Over the first six months, the market achieved sales of approximately 7.69 million units, reflecting a 12.3% increase from the same period in 2022. The demand for automobiles remains strong, indicating that the rise in interest rates has not yet significantly affected purchasing decisions. Quoting Cox Automotive's chief economist Jonathan Smoke, "Consumers have found a way to buy new wheels.” Although the Fed has indicated the possibility of more rate hikes in the near future, the U.S. vehicle sales outlook for 2023 remains strong. Cox Automotive forecasts full-year vehicle sales at around 15 million units, up from 13.9 million units in 2022.

Improving Inventory Levels: Supply constraints have been considerably alleviated. Limited new-vehicle inventory over the past two years that had handcuffed sales is no longer a pressing concern. According to Cox Automotive, new vehicle inventory levels in the United States saw a significant increase of more than 70% in July compared to the same period last year. This increase in inventory availability bodes well for the industry, signaling a potential shift toward a more balanced state between supply and demand. Robust inventories are leading to richer incentives and sweeter discount deals. Incentives increased for the 10th straight month in July to the highest level since October 2021. All these factors are driving the prospects of the industry.

Soaring EV Popularity: Heightened climate change concerns, advancements in technology, and strict fuel-emission regulations are resulting in the widespread adoption of eco-friendly vehicles. The demand for electric vehicles is on an upward trajectory, consistently setting new sales records. Last year was the biggest for zero-emission vehicles in the United States. Additionally, 2023 is poised to be a landmark year, with U.S. EV sales projected to surpass 1 million units for the first time. Established car manufacturers are putting in substantial efforts to establish a strong presence in the thriving e-mobility sector. Further, the Inflation Reduction Act is expected to provide a further boost to EV sales. With this ongoing momentum and the anticipated growth ahead, the U.S. auto industry's outlook in the EV market appears promising.

Zacks Industry Rank Indicates Solid Prospects

The Zacks Automotive – Domestic industry is an 18-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #72, which places it in the top 29% of around 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates encouraging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential.The industry’s earnings estimates for 2023 have increased 7% over the past six months.

Before we present you two top-ranked stocks from the industry, let's take a look at the industry’s stock market performance and current valuation.

Industry Lags S&P 500 & Sector

The Domestic Auto industry has underperformed the Zacks S&P 500 composite and sector over the past year. The industry has lost 14.2% against the S&P 500’s growth of 15.1%. The sector has declined 7.1% over the said time frame.

One-Year Price Performance

Industry's Current Valuation

Since automotive companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/Earnings before Interest Tax Depreciation and Amortization) ratio. On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 17.49X compared with the S&P 500’s 13.46X and the sector’s 12.53X. Over the past five years, the industry has traded as high as 58.44X, as low as 8.78X and at a median of 18.54X, as the chart below shows.

EV/EBITDA Ratio (Past Five Years)

2 Stocks to Buy

General Motors: One of the world’s largest automakers, General Motors held the largest share of the U.S. auto market at 16% in 2022. General Motors’ compelling portfolio with strong demand for its quality full-size pickups and SUVs bodes well. The company’s hot-selling brands in America like Chevrolet Silverado, Equinox and GMC Sierra are driving the top line.  Encouragingly, this legacy U.S. automaker will have nine EV models in the North America market this year, which will buoy top-line growth. The company's Ultium platform and battery plants in Ohio, Tennessee and Lansing are set to scale up its e-mobility prowess. Its superior liquidity profile also instills confidence. General Motors’ strides in autonomous vehicle development also augur well for long-term growth. 

GM currently has a Zacks Rank #2 (Buy) and a Value Score of A. The Zacks Consensus Estimate for General Motors’ 2023 sales implies year-over-year growth of 9.25%. The consensus mark for GM’s 2023 and 2024 EPS has moved north by 12 cents and 15 cents, respectively, over the past 30 days. Over the trailing four quarters, the stock surpassed estimates on three occasions and missed once, the average surprise being 22.6%.

Price & Consensus: GM

PACCAR: Headquartered in Bellevue, PACCAR is one of the leading names in the trucking business with reputed brands like Kenworth, Peterbilt and DAF. The new DAF lineup, comprising the XF, XG and XD models, is driving the firm’s revenues. Continued growth in aftermarket parts — which is a high margin and a less cyclic business, thanks to the rampant adoption of its proprietary MX engine — bodes well. Accelerated efforts toward electrification, connected vehicle services and advanced driver-assistance system options are set to bolster PACCAR’s prospects. A solid balance sheet with low leverage is another tailwind. PACCAR’s strong balance sheet is complemented by A+ and A1 credit ratings assigned by Standard & Poor's and Moody's, respectively. 

PACCAR currently carries a Zacks Rank #2 and has a VGM Score of A. The Zacks Consensus Estimate for PACCAR’s 2023 sales and earnings implies year-over-year growth of 19% and 48.5%, respectively. The consensus mark for PCAR’s 2023 and 2024 EPS has moved north by 70 cents and 38 cents, respectively, over the past 60 days. Over the trailing four quarters, the stock surpassed estimates on all occasions, the average surprise being 15.2%.

Price & Consensus: PCAR

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



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