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Industry Outlook

The auto sector has been benefiting from rising global sales in recent years. So far this year, the key U.S., China and Europe auto markets have reported strong sales volumes, driven by high incentives and attractive vehicle launches. Moreover, low fuel prices are boosting sales of higher margin vehicle segments, such as SUVs and light trucks.

However, massive recalls due to defective Takata airbag inflators and the Volkswagen AG (VLKAY - Snapshot Report) emission scandal are hurting the auto sector. Moreover, sales growth in Europe is expected to be slower this year, while sales in the U.S. are likely to hit a plateau.

Still, there are plenty of reasons to be optimistic on the broader auto industry for both the short and long term. Below, we discuss some of the key factors that should continue to drive the sector’s performance level in the near to medium term.


Rising Sales in China

Many automakers, including the likes of Ford Motor Co. (F - Analyst Report) and General Motors Company (GM - Analyst Report) , have been banking on strong sales growth in China to drive earnings over the next few years. Naturally, when auto sales in China started falling in mid-2015, concerns were raised. Thankfully, the situation reversed from September.

Consequently, auto sales increased 4.7% year over year to a record 24,597,600 units in 2015. Sales of passenger cars increased 7.3% to 21.1 million units, crossing 20 million for the first time. However, sales of commercial vehicles declined 9% year over year.

This year, both passenger cars and commercial vehicles have been recording strong sales in China. Sales of passenger cars increased 11.1% year on year to 12.65 million units in the first seven months of 2016, while sales of commercial vehicles increased 2.4% to 2.04 million units. Consequently, total automobile sales surged 9.4% year over year to 14.68 million.

Strong Sales in the U.S.

U.S. light-vehicle sales inched up 0.5% in the first eight months of 2016. Although the percentage of increase was low, sales volumes remained strong. Moreover, the rise is commendable given that sales hit an all-time record in 2015. Results were driven by low fuel prices, easy availability of credit, attractive incentives and economic stability. Product segments like trucks and utility vehicles continued to record strong sales.

Most analysts expect U.S. auto sales to improve further in 2016, driven by rising employment and personal income as well as low fuel prices. Moreover, the high average age of cars on U.S. roads should continue to boost replacement demand for cars as well as car parts. The average age is currently 11.5 years which is expected to rise 3% by 2020, according to forecasts by IHS Automotive. This will benefit replacement parts manufacturers and retailers, apart from new vehicle manufacturers and retailers.

Sustained Recovery in European Union

New passenger car registrations in the European Union increased 8.1% to 9.8 million units in the first eight months of 2016 as per the European Automobile Manufacturer’s Association. All major markets posted strong growth during the period. Rising consumer confidence, good incentives, strong replacement demand and new product launches are giving a boost to sales.

Following six years of decline, sales of passenger cars in the European Union turned around with a 5.7% year-over-year increase in 2014. The recovery continued in 2015 with a 9.3% year-over-year increase in passenger car registrations. Sales are expected to improve further this year.

Low Gas Prices

Gasoline prices remain significantly low, thus benefiting automakers significantly. As fuel becomes affordable, sales of gasoline-powered vehicles – especially the larger ones that carry a wider profit margin – get a boost.

Although sales of hybrids and electronic vehicles are suffering from this trend, the sales volume of such vehicles is significantly lower than gasoline-powered vehicles. Hence, the positive impact of low gas prices outweighs the negatives for the auto sector.

Attractive Vehicle Launches

Rising sales and intense competition are encouraging automakers to come up with new and attractive, technologically advanced vehicles to gain market share. Most automakers are also revamping their popular vehicles by adding new technologies and enhancing their visual appeal to revive sales.

These companies are also offering attractive optional features in vehicles to scoop up more profits. These features provide scope for surplus revenue generation from small cars, which have lower profit margins than large trucks.

Focus on Vehicle Safety Beneficial for Parts Makers

Increasing focus on the safety of vehicles is benefiting parts manufacturers, specifically those dealing with automotive safety products. For example, last year, 10 major automakers agreed to offer automatic emergency braking (AEB) systems as a standard feature in all their vehicles in the U.S. Apart from ensuring better road safety, this move will also benefit auto parts manufacturers that produce AEB systems.

Bottom Line

The auto industry has many favorable factors to drive growth. According to IHS Automotive, global auto sales are expected to rise 2.7% to nearly 89.8 million units in 2016. This presents a good buying opportunity for investors with a longer-term horizon. Some auto sector companies worth considering are Superior Industries International, Inc. (SUP - Analyst Report) , Tata Motors Limited (TTM - Snapshot Report) , Tenneco Inc. (TEN - Analyst Report) and Standard Motor Products, Inc. (SMP - Analyst Report) , all sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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

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