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Industry Outlook

Zacks Equity Research

Auto Industry Stock Outlook - June 2016

VLKAY TM GM

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Auto Stock Outlook: Can Strength Be Sustained?

Last earnings season was particularly exceptional for the auto sector, with not only the sector handily beating estimates, but also producing the best year-over-year earnings growth rate of all sectors in the S&P 500. Strong sales in the U.S., China and Europe helped both the top and the bottom lines of automakers. Meanwhile, the bottom line also benefits from an increase in sales of higher-margin vehicle segments, such as SUVs and light trucks, due to low fuel prices.

However, expenses related to safety recalls and negative currency effects are some headwinds. The negative impact of foreign currency translation had a significant adverse effect on revenues of many companies. Meanwhile, the auto sector is still reeling from massive recalls related to Volkswagen AG’s (VLKAY - Free Report) emissions scandal and Takata Corp’s defective airbag inflators.

The Volkswagen emissions scandal also cost the German automaker the chance to be the highest selling automaker last year. While it was the leading contender for the position before the scandal broke out, the loss in sales thereafter positioned Toyota Motor Corp. (TM - Free Report) as the top contender.

Toyota reported global sales of 10.15 million units in 2015, surpassing Volkswagen and General Motors Co. (GM - Free Report) to become the leading automaker for the fourth year in a row. The second position was held by Volkswagen, with global sales of 9.93 million vehicles in 2015. However, as expected, the German automaker’s sales fell 2% from 2014 due to the negative impact of the emission scandal. With sales of 9.8 million vehicles, General Motors came in third.

Despite the negatives, the auto sector had a good run in the first quarter. The projections for the second quarter also look favorable. However, the projections for the latter half of the year are not promising.

Zacks Industry Rank – Mixed Outlook

The distinctive attributes of the auto industry prompted us to have a dedicated sector for the industry in our database. The automobile sector is one of the 16 Zacks sectors, unlike the S&P classification, wherein autos are part of the Consumer Discretionary sector. The S&P has 10 sectors compared to the 16 sectors for Zacks.

At the expanded classification level, the Zacks auto sector is divided into five industries: Auto-Domestic, Auto-Foreign, Auto/Truck-Original, Auto/Truck-Replacement and Engines. The sector’s retail operations are part of the Zacks Retail sector in two industries: Auto/Trucks and Other Auto Parts. The level of sensitivity and exposure to the different stages of the economic cycle vary for each industry.

The current Zacks Industry Rank is #182 for Auto-Domestic, #229 for Auto-Foreign, #17 for Auto/Truck-Original, #81 for Auto/Truck-Replacement, #197 for Engines, #202 for Retail/Wholesale Auto/Truck and #110 for Retail/Wholesale-Auto Parts. As a reference point, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,’ between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.’

This implies that the outlook for auto-related industries is mixed, yet leaning toward the negative side. We rank all 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.

Sector Level Earnings Trend

The auto sector is expected to contribute 2.5% to total S&P 500 earnings in 2016. This is more than double its 1.1% market cap weight in the index at present.

Looking at the overall results of the auto sector, earnings surged 53.2% year over year in the first quarter of 2016 compared with 8.5% in the fourth quarter of 2015. Auto sector earnings are expected to rise 9.1% in the second quarter of 2016, placing the auto sector among the winners in terms of sectors covered by Zacks. Thereafter, earnings are expected to fall 4.1% in the third quarter and 9.2% in the fourth quarter, placing the sector among the laggards.

Total revenue increased 0.6% year over year in the first quarter of 2016 against a 1.3% year-over-year fall in the prior quarter. Revenues are expected to move up 1.8% in the second quarter but fall 2.3% and 0.9% in the third and fourth quarters, respectively.

For more information on earnings for this sector and others, please read our latest 'Earnings Trends' report.

Bottom Line

The auto sector is currently facing several opportunities as well as challenges. While low fuel prices, attractive financing options and impressive vehicle launches are boosting vehicle sales, there are headwinds like slowing sales growth in Europe, negative impact of currency translation and the high levels of safety recalls.

Nevertheless, the outlook for global vehicle sales for 2016 remains strong with the projection of a 2.7% rise to nearly 89.8 million vehicles by IHS Automotive.

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