Is The Worst Over For Car Manufacturers?

Against a generally booming market, shares of carmakers have gone nowhere over the last five years. The First Trust Global Auto Fund (NYSE: CARZ) is down 8.9% over the period versus a 70% return on the S&P 500.

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Why have carmakers stalled even as stocks enjoy the longest bull market ever?

The slow sell-off in traditional carmakers has left shares in value territory with the five largest publicly-traded companies, Toyota, Honda Motors, Daimler, General Motors and Ford, trading at an average of just 6.5 times trailing earnings.

If you’re looking for “blood in the streets” in an otherwise exuberant market, there may be no better place than your own garage.

Why Have Car Stocks Stalled?
Sales for cars and light trucks surged after the recession with the “cash for clunkers” program and reached nearly 18 million vehicles sold on an annual basis. The stimulus brought car sales forward and has since turned into a terrific hangover.

#-ad_banner-#Carmakers are struggling to sell new cars with relatively fewer buyers left, and August 2018 sales were just 16.5 million vehicles on an annualized basis. A shift in consumer tastes to crossovers caught many manufacturers off guard and didn’t help matters.

More recently, rising commodity costs for steel and aluminum have forced downward revisions to forecasts during second quarter calls. Talks of a trade war between the U.S. and several foreign markets, as well as a renegotiation of NAFTA, have kept investors on the sidelines.

But are investors ignoring strong long-term demand and a value in shares of major car brands?

More than 81 million cars and light trucks are expected to be sold worldwide this year, according to Statista. With just 1.2 billion drivers against a global population of 7.3 billion, that leaves a lot of room for growth in what’s typically thought of as a mature industry.

Can Car Stocks Drive Higher Returns Into 2019?
Even as auto manufacturing and trade continues to be a geopolitical flashpoint, there is reason to believe shares of car companies could present a buying opportunity.

The pain at Tesla with investors falling out of love with Elon Musk could bring sentiment back to traditional makers and their electric vehicle line-up. Value in the shares is already attracting activist investors with Paul Singer’s Elliot Management opening a $17 million investment in Ford earlier this year.

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Manufacturers are restructuring to focus on profitability and core models to counter the stagnation in sales. Earnings are expected lower for most major manufacturers over the next year, but the outlook should brighten quickly as margins improve and sales eventually rebound as the average age of cars on the road increases.

The fact is that people will be driving cars for a very long time and the pain in shares of major producers is largely a function of the post-crisis boom in sales. Car stocks are one of the few industries seeing “blood in the streets” against an almost universally overpriced market.

Positioning in deep value now can help drive strong returns later when car manufacturers rebound and the rest of the market stumbles.

Ford Motor Company (NYSE: F) has been shifting to common platforms in its manufacturing process, producing on nine platforms in 2016 versus as many as 27 in 2007. The move enables the company to shift production faster to meet changing demand and reach better economies of scale.

Ford reported mixed August sales with its SUV and crossover segment growing 20% year-over-year on unit volume while its car lineup suffered. Management is estimating $11 billion in restructuring charges over the next three to five years which will restrict cash flow but gradually lead to a stronger balance sheet.

Shares trade for just 8.1 times trailing earnings and pay a 6.4% dividend yield. Earnings are expected to lower by 3.8% over the next year, and the dividend payment may need to come down to protect cash flow. The average analyst price target of $11 per share represents a 16% premium to the current trade.

General Motors (NYSE: GM) is also modernizing its production onto four vehicle platforms for flexibility and scale efficiencies. This combined with the decision to cut to four brands, Chevrolet, Cadillac, Buick and GMC in North America, should drive profitability.

GM has made a proactive investment in ride-sharing with a 9% stake in Lyft that could help protect it from a future where people rely on car services rather than their own vehicles. Speculation has been building since last year that the company could spin off its self-driving car unit for as much as $30 billion, according to Deutsche Bank analysis. Activist investor David Einhorn made an unsuccessful attempt for board seats last year but still owns nearly 40 million shares in the company.

Shares trade for an astonishing 5.5 times trailing earnings, though profits are expected to lower by 6% over the next four quarters. That still leaves the shares at a 5.9 times forward multiple with a 4.3% yield. The average analyst price target of $46.53 represents a 34% premium to the current trade.

The trade war could become an opportunity for foreign carmakers to steal market share from U.S. companies abroad. Investors should look for diversification in the best-of-breed foreign manufacturers as American exports become more expensive on tariffs.

Tata Motors Limited (NYSE: TTM) has a significant advantage in its home market of India with tariffs of up to 200% on imported vehicles. A depreciation in the rupee over the last few years has also made foreign cars relatively more expensive and protected the company’s 45% market share in this growing market.

Besides its mass market passenger and commercial lineup, Tata enjoys higher profitability and recognition in its Jaguar and Land Rover brands. Revenue from the JLR segment has grown by 17% annually with global volume up 8% since the brands were acquired in 2009.

Tata is one of the few car makers expected to grow earnings over the next year with profits expected to climb 49% to $2.40 per share inn 2019. Shares are relatively expensive at 7.5-times forward earnings versus U.S. peers like Ford and GM but reflect a strong outlook in India and emerging Asia. The average analyst price target of $27.50 represents a 15% premium on the current share price.

Risks To Consider: Auto manufacturing is typically a cyclical industry and could get hit in an eventual recession even though price-to-earnings ratios are already extremely low.

Action To Take: Take advantage of low prices in carmakers to position ahead of stronger investor sentiment and higher multiples.