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Foreign Auto Industry Outlook: Multiple Headwinds Prevail

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Companies in the Zacks Automotive – Foreign industry are involved in designing, engineering, manufacturing, distributing, and selling vehicles, components as well as production systems. Some of these companies are also engaged in research and development of electric and autonomous vehicles, fuel efficiency, along with low-emission technology.

Let’s take a look at the three major industry themes:

 

  • The foreign automotive industry, being consumer cyclical, is dependent on business cycle and economic conditions. The industry is in disarray amid weak vehicle demand and falling consumer confidence due to coronavirus woes. Sluggish demand in the world’s biggest auto market, China, has been hcarmakers in doing brisk business in the country. Indeed, auto sales in China have witnessed a rebound in April and May. However, amid the prevailing macro-economic conditions, vehicle sales in China are expected to fall 10% year over year in 2020. As it is, the nation’s EV sales have taken a beating since July 2019 due to policy reversals on government subsidies for new energy vehicles. The trend is not likely to reverse anytime soon.

 

  • Demand for passenger cars in other major markets including Europe and Japan have pummeled. Per OECD's latest reports, a second wave of the virus this autumn could shrink the economy by 15% by the end of the year. Amid serious worries over economic recession in major markets of Europe, customers are likely to put off discretionary purchases like cars. As the industry is fighting tough CO2 rules and consumers are worrying about a recession, automakers in Europe are having a tough time. Industrial watchdogs expect significant fall in European auto sales in the coming months. The outlook for new vehicle sales in Japan appears gloomy. With major COVID-19 impacts likely to be felt in the second quarter, Japan is bracing for the worst economic slump since the Second World War. 

 

  • The industry is witnessing considerable changes in operating environment. Widespread usage of technology and rapid digitization are resulting in fundamental restructuring of the automotive market. A shift toward electric and self-driving vehicles has made it necessary for industry players to reorient their business model. A host of factors such as pollution issues, technical superiority, stricter fuel-emission standards, and increasing adoption by both automakers and customers work in favor of electric vehicles. Rapid progress in artificial intelligence and machine learning is making the seemingly utopian concept of driverless cars a reality. Considering the changing dynamics, companies are required to make huge investments to bring a radical change in the business models of auto companies.

 

Zacks Industry Rank Indicates Glum Prospects

The Zacks Automotive – Foreign industry is a 19-stock group within the broader Zacks Auto sector. The industry currently carries a Zacks Industry Rank #216, which places it in the bottom 15% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all member stocks, indicates bleak near-term prospects. 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.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimates for the current year have declined 61.6%.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags S&P 500 & Sector

The Zacks Automotive – Foreign industry has lagged the Auto, Tires and Truck sector and Zacks S&P 500 composite over the past year. The industry has declined 4.2% against the S&P 500 and sector’s rise of 2.1% and 10.1%, respectively.

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. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by the changing capital structures and ignores the effect of non-cash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), which is a commonly used multiple for valuing auto stocks, the industry is currently trading at 6.68X compared with the S&P 500’s 11.14X and sector’s 10.58X.

Over the past five years, the industry has traded as high as 7.72X, as low as 5.32X and at a median of 6.65X, as the chart below shows.

Trailing 12-Month Enterprise Value-to-EBITDA (EV/EBITDA) Ratio

 

Bottom Line

The COVID-19 pandemic has resulted in unprecedented challenges for the auto sector, creating a demand shock as consumers’ confidence has dropped significantly. Further, the possibilities of a second COVID-19 wave loom large. Contracting demand amid global economic slowdown, challenging market conditions and tougher emission rules across the globe is likely to remain concerns in the near term.The pandemic is likely to dent near-term cash flows and weaken the balance sheets of various auto firms. Hence, the overall sentiment surrounding the industry is extremely bleak.

None of the stocks in the industry sport a Zacks Rank #1 (Strong Buy). So we are presenting one Rank #2 (Buy) stock that is poised for growth and three stocks with a Zacks Rank #3 (Hold) that investors may choose to retain in their portfolios. You can see the complete list of today’s Zacks #1 Rank stocks here.

Mazda Motor Corporation (MZDAY - Free Report) : Japan-based Mazda Motor currently carries a Zacks Rank #2. The Zacks Consensus Estimate for EPS for the current year has moved up 11 cents over the past 90 days to 32 cents a share.

One-Year Price Performance: MZDAY

Fiat Chrysler Automobiles (FCAU - Free Report) :This Italian-American carmaker has a Zacks Rank #3 at present. The Zacks Consensus Estimate for loss for the current year has narrowed by 5 cents over the past 30 days to 69 cents per share.

One-Year Price Performance: FCAU

Daimler AG (DDAIF - Free Report) :Headquartered in Germany, Daimler currently carries a Zacks Rank #3. The Zacks Consensus Estimate for 2020 EPS has moved up 50% over the past seven days to 63 cents a share.

One-Year Price Performance: DDAIF

NIO Inc. (NIO - Free Report) : Based in China, NIO carries a Zacks Rank #3 presently. The Zacks Consensus Estimates for 2020 earnings suggests year-over-year growth of 42.5%.

One-Year Price Performance: NIO

 

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