Stock Investing

As the U.S. auto market works its way through a slump, the rest of the world is picking up the slack.
By Vikram Barhat | 04/10/17

The U.S. automotive sector is going through a rough patch. Moody's predicts that auto sales will fall 3.6% this year. Worse, the weakness in the sector is forecasted to drag on for 18 months. In a stark contrast, though, car sales in Canada have been clocking record numbers almost every month this year.

About the Author
Vikram Barhat is a Toronto-based financial writer specializing in investing, personal finance and small business. His experience working in various editorial capacities in digital and print media spans 15 years across three continents. He is also a former content editor of Advisor's Edge and Advisor.ca. He can be reached at vikrambarhath@gmail.com.

For auto manufacturers, and investors, this divergence is a good sign. It means that the rest of the global auto market, especially in developing economies, is picking up the slack as the U.S. market works its way through the slump. In fact, a recent Morningstar report forecasts strong global growth in the auto industry. Similarly, a Scotiabank report says global car sales are indeed poised for an eighth consecutive annual record, powered by acceleration in emerging economies as well as resurgence in Latin America bouncing after a three-year decline.

Record global sales, says the Scotiabank report, reveal a clear disconnect between the reality and widespread fears and pessimism in the mainstream media.

Thankfully, automaker stocks appear to be just as disconnected to the bearish sentiment that besets the industry. The leading carmakers, in various stages of recovery from safety recalls, class action suits, and regulatory setbacks, are showing signs of revival, most of their stocks in the green on a year-to-date basis. Select auto stocks are also trading at a discount to their fair value, offering some margin of safety, and are well positioned to maintain their market leadership while navigating a shifting automotive landscape, political headwinds and newer trends feared to upend traditional business models, according to Morningstar equity research.

 

Ford Motor Co.
Ticker:F
Current yield:4.96%
Forward P/E:7.5
Price:US$11.97
Fair value:US$14
Data as of Sept 29, 2017

Maker of the Ford and Lincoln car brands,  Ford Motor Co. (F) has a 14.8% market share in the United States and nearly 8% in Europe. Sales in North America and Europe made up nearly 65% and 20% of 2016 auto revenue, respectively.

"We remain optimistic about Ford's long-term prospects because the company now makes cars people actually want to own instead of vehicles that are purchased only because of heavy incentives," says a Morningstar equity report.

Ford's challenge, the report adds, is to keep growing share profitably and to raise Lincoln's status to a global luxury brand. Taking on its U.S. and European rivals, Ford's Lincoln has already announced its plans to manufacture luxury SUVs in China by late 2019, according to Reuters.

To improve efficiency and reduce costs, the company is building more Ford models on common platforms. Ford moved from 27 platforms in 2007 to just nine platforms which were responsible for 99% of its global production in 2016. "This change should save Ford billions of dollars in development costs," says Morningstar sector strategist, David Whiston.

More recently, Ford pushed further into the more profitable luxury market with the newest F-450 truck that tops US$100,000, due to roll out later this year. The luxury pick-up truck, its priciest after the US$450,000 GT Supercar, is one of many ways the automaker is exploring new growth opportunities.

"A strong luxury group will increase profits because it will allow Ford to sell to all consumer variants while retaining current Ford customers and selling Lincolns for more profit than Ford brand vehicles," says Whiston, who pegs the stock's fair value at US$14.

 

General Motors Co.
Ticker:GM
Current yield:3.61%
Forward P/E:7.1
Price:US$40.38
Fair value:US$51
Data as of Sept 29, 2017

The largest automaker in the U.S.,  General Motors (GM) remains the market leader in the U.S. with 17.3% share in 2016. The carmaker, whose brand portfolio includes names such as Chevrolet, GMC, Buick and Cadillac, sold nearly 10 million vehicles globally in 2016, the bulk of which in China, its largest market, and in the U.S.

"We think GM's earnings potential is excellent because it finally has a healthy North American unit and can focus its U.S. marketing efforts on just four brands instead of eight," says a Morningstar equity report. "The company is already a leader in truck models, so a competitive lineup in all segments, combined with a much smaller cost base says to us that GM is starting to realize the scale to match its size."

Given the enormity of the U.S. market for light vehicles, Whiston expects GM to report "excellent earnings growth as vehicle demand comes back during the next few years."

That consumers are now willing to pay more for its vehicles than they did in the past means GM no longer has to rely on volume to cover high labour costs. "It now operates in a demand-pull model where it can produce only to meet demand, is structured to do no worse than break even at the bottom of an economic cycle, and is about to see the upside to having a high degree of operating leverage," says Whiston, whose US$51 fair value for the stock sits nearly 25% above its current market price. "The result is more profits despite less U.S. market share."

Additionally, GM has embraced the industry transformation by investing US$500 million in the ride-sharing and ride-hailing company Lyft, which provides GM a footing in the autonomous-vehicles market.

 

Volkswagen AG ADR
Ticker:VLKPY
Current yield:1.34%
Forward P/E:1.1
Price:US$32.71
Fair value:US$49
Data as of Sept 29, 2017

European auto manufacturer  Volkswagen AG (VLKPY) makes passenger cars under the Volkswagen brand and owns premium brands including Bentley, Porsche, Audi, Bugatti and Lamborghini. The company also manufactures commercial vehicles and provides consumer financing for vehicle purchases.

Uncertainty around the ongoing diesel engine scandal, which could be a drag on the German carmaker for some more time, has depressed the stock price, creating a buying opportunity for long-term investors with some tolerance for risk. The regulatory overhang, however, isn't likely to break the company. "With a bevy of new and redesigned model introductions, and leading shares in many of the world's markets, as well as a healthy pile of cash, Volkswagen is well buffered to endure potentially substantial fines and judgments," says a Morningstar equity report. "Global demand for Volkswagen products has been steady to slightly higher despite the potentially brand-crippling news."

Volkswagen's geographically diverse and profitable operations and a broad array of brands reduce the company's dependence on any one market or vehicle category, says Morningstar equity analyst Richard Hilgert.

Further, a substantial cash pile and conservatively financed capital structure provide Volkswagen a high degree of financial flexibility, adds Hilgert, who appraises the stock's fair value to be US$49 per American Depositary Receipt (ADR).

The company generated EUR1.8 billion in free cash flow in 2016, and combined with operational cost reductions, supports "management's efforts to offset costs related to the diesel crisis while maintaining product development and a dividend," says Hilgert.

 

Fiat Chrysler Automobiles NV
Ticker:FCAU
Current yield:-
Forward P/E:6.1
Price:US$17.91
Fair value:US$21
Data as of Sept 29, 2017

The world's seventh largest car company,  Fiat Chrysler Automobiles NV (FCAU) sells globally under well-known brands that include Fiat, Chrysler, Dodge and Alfa Romeo, and owns luxury brands such as Ferrari and Maserati. It also makes automotive parts and industrial robots.

A significant part of Fiat's growth is tied to its expansion in emerging markets. "As a market leader in Brazil, Fiat will benefit from a rising middle class," says a Morningstar equity report.

The company was late to Russia, India and China and "lags already-established competitors' market shares," but still is positioned to benefit from the above-industry-average growth in demand in these markets, notes Hilgert, adding "Jeep's re-entry into China provides Fiat with a boost to volume and profits, too."

In another report, Morningstar equity analyst Nick Mokha says Fiat stands to significantly benefit from the growing global popularity of sports and crossover utility vehicles. "The company has realigned North American capacity for more pickup, SUV and crossover volume," says Mokha, noting the company is expanding Jeep production globally.

Maserati Levante and Alfa Romeo Stelvio, he adds, are the other new, premium crossovers set to hit global markets this year and next.

Fiat increased the revenue target for its five-year plan (2014-2019) from EUR 96 billion to EUR 136 billion, and EUR 4 billion to EUR 5 billion in cash in 2018. However, investors appear to view these objectives with suspicion. "The market's lack of response to the plan target increase makes our case even more potent that the investment community has misunderstood Fiat Chrysler's ability to increase revenue, generate cash and repay debt," says Hilgert, who estimates the stock is worth US$21.

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