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Recalls and ForEx Hinder Auto Sector Growth

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Massive auto recalls are giving consumers and automakers a major headache. The negative effect of currency translation, weakness in passenger car sales in the U.S. and expected slow growth in auto sales in Europe are the other concerns of the auto industry.

However, there are several positives such as low gas prices, impressive U.S. and China sales and sustained recovery in Europe. Moreover, focus on vehicle safety is benefiting parts manufacturers, specifically those dealing with automotive safety products.

Still, there are plenty of reasons to be careful about the auto industry stock space for both the short and the long terms. Below, we discuss some of the key challenges that investors in the auto sector should watch out for in the coming months and years:

Cost of Safety Recalls

Safety recalls and related costs have become a major issue for most automakers in recent years. Per the National Highway Traffic Safety Administration (NHTSA), auto recalls in the U.S. hit 51.26 million units in 2015, setting a new record. In total, automakers announced nearly 900 recalls last year, also a new record.

The previous record for both the number of recalls and the number of vehicles recalled was set in 2014, when automakers announced 803 recalls covering 50.99 million vehicles. Notably, these figures only cover the recalls in the U.S. and the global recall numbers are much higher.

Auto recalls are set to be high this year as well, thanks to the defective Takata airbag inflators, which resulted in significant recalls in 2014 and 2015. Recently, the NHTSA ordered automakers to recall another 35–40 million Takata airbag inflators in the U.S. by 2019, making it the largest auto recall in the country. Around 24 million vehicles with 28.8 million airbag inflators have already been recalled for the defect.

The expanded recall includes three new automakers – Tesla Motors, Inc. (TSLA - Free Report) , Fisker Automotive and Jaguar Land Rover. This takes the total affected automakers to 17.

The Volkswagen AG (VLKAY - Free Report) emission scandal is also resulting in a large number of recalls. However, these are not included in the figure given by the NHTSA as this is a standards violation and not a safety issue.

Apart from this, stricter implementation by the government contributed to the large number of recalls. High fines imposed on many automakers for delay in reporting safety issues also prompted many companies to proactively announce safety recalls.

The recall-related repair costs increase the financial burden of auto manufacturers. A massive recall can also hurt sales volume as consumers start questioning the brand’s safety.

Negative Impact of Foreign Currency Translation

The negative impact of foreign currency translation remains a major headwind for the auto sector. A strong dollar resulted in significant adverse effect of currency translation on revenues of U.S. automakers in the last few quarters. Meanwhile, this has been helping Japanese automakers like Honda Motor Co., Ltd. (HMC - Free Report) , Toyota Motor Corp. (TM - Free Report) and Nissan Motor Co. Ltd. (NSANY - Free Report) .

However, the recent strength of the yen weighed on the financials of these automakers in the quarter ended Mar 2016. Moreover, these Japanese automakers expect a negative impact of nearly $14 billion in operating profit this year due to the strong yen.

Weak Passenger Car Sales in the U.S.

While strong demand for trucks has been driving the U.S. auto market, sales of passenger cars have been falling. Last month, passenger car sales fell 16% in the U.S., pulling down the total light vehicles sales for May by 6.1% year over year. This is the biggest fall in U.S. sales in nearly six years. While two fewer selling days compared with May 2015 mattered a lot, the main culprit was the weakness in passenger car demand. On top of this is the question of whether sales can get any better, meaning that the best is likely behind us.

Slower Sales Growth in Europe

Although the European auto market is recovering, it is expected to witness slower growth this year. Per the European Automobile Manufacturer’s Association, passenger car sales are expected to increase only 2% in 2016 compared with 9.3% growth recorded in 2015.

Market Share Concentration

The majority share of the automobile market is held only by a few leading automakers. This makes the automobile sector highly competitive. The top 10 global automakers account for nearly 81% of the total vehicles sold, according to

Moreover, high dependence on these automakers makes auto parts suppliers vulnerable to pricing pressure and production cuts. Pricing pressure from automakers constricts margins of parts suppliers. Simultaneously, frequent production cuts by automakers to cope with market adjustments affect suppliers’ operations.

Some auto industry suppliers that are highly dependent on a few major automakers are Meritor Inc. (MTOR), Tenneco Inc. (TEN) and Magna International Inc. (MGA). The full list can be seen in this auto supplier page.

Bottom Line

While the auto industry has several reasons to be optimistic on the near-to-medium term, a number of long-term challenges remain.

Check out our latest Auto Industry Outlook here for more on the current state of this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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