There were numerous interesting takeaways from the Wolfe Research Auto Conference in Detroit, including revealing insights into recent shifts amongst U.S. New Vehicle Buyers (there may be less risk to industry mix than we perceived), the trajectory of battery costs, insights into Powertrain plans being made by Auto OEMs, and revelations on the Ride-Share business model. All of these have long term implications.
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There were 3 major takeaways from GM’s CMD on Friday (1/11/19): 1) Prospective tailwinds appear to significantly exceed potential headwinds for GM’s core Auto business; 2) GM’s earnings runway is much longer than the Street appreciates (extends into 2020 and beyond), and; 3) GM reinforced our view that they are on track to achieve impressive value creating milestones at Cruise. Investor confidence is the primary driver of multiple expansion/contraction for Auto Stocks. Confidence in GM’s prospects should be on the rise. And the opportunity for upside is compelling. We reiterate our Buy, $50 target.
After 2.5 frenetic days at CES, we’d report the following key takeaways: 1) Multiple industry leaders are acknowledging (primarily behind the scenes) that deployment of Level 4 / 5 Autonomous Driving technology without safety drivers is farther away than most public targets. At the same time, demand for consumer-targeted safety / convenience systems (primarily Level 2+) continues to accelerate. 2) Reinforcement of the narrative that the next generation of high-volume internal combustion engine / transmission families will be the last one for many automakers.
No surprise, Ford announced the beginning of what is likely to become a major restructuring plan for its underperforming European business. Details are sparse. Ford did not provide any info on the cost (restructuring in Europe can cost $350k/head) or timing of benefits (we would not expect achievement of Ford’s 6% margin target until 2021, at the earliest). Per Ford’s release, they are “accelerating key fitness actions and reducing structural costs. In parallel, the fundamental redesign will include changes to Ford’s vehicle portfolio, expanding offerings and volumes in its most profitable growth vehicle segments, while ... addressing underperforming markets.”
The Market is bracing for challenges as we transition to 2019, including lower Auto Production (particularly in China and Europe during 1H19), higher Rates (which raise concerns about Mix, Pricing), the strong U.S. Dollar, Regulatory Content, unpredictable Government Policy/Tariffs, the burden of increased Spending on Technology with uncertain returns, and in some cases discontinued passenger car products.
Most major U. S. OEMs and Suppliers will provide 2019 guidance in mid- to late-January… at our Detroit Auto Show Conference (Jan 15-16), or when they deliver Q4 earnings late January/early February. Management teams are pulling these forecasts together now. And they are doing so amid an unusually large number of market uncertainties (i.e. China, Europe, and NA production; company specific concerns for Ford (China, UK), JLR (China, UK), GM (discontinuing models), and local Chinese OEMs (declining at a double-digit rate in their domestic market). Based on our discussions with Industry Management teams we suspect that most will incorporate an extra dose of conservatism into their 2019 Guides. We are fine-tuning our estimates for Lear, Visteon, and Autoliv as we intend to take the same tack (e.g. today, we are fine-tuning our 2019 net new business backlog estimates, initially provided in early 2018, to reflect updated market and FX assumptions). See pages 3-6 for more details.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
Late Sunday night (12/02/18), President Trump tweeted that China had agreed to reduce the tariff on vehicles produced in the U.S. and exported to China (China had increased this tariff from 15% to 40% in August). In addition, the U.S. will refrain from ratcheting up tariffs (would have gone from 10% to 25%) on $10.4 bn of Chinese made Auto Parts that are imported to the U.S. Although we have no detail as of yet, and these actions are contingent on the U.S. and China making progress towards a permanent trade agreement over the next 90 days, this development could have meaningful positive implications for U.S. Automakers and Suppliers:
The $6 bn cash flow savings ($4.5 bn operating cost and $1.5 bn capex) is so large, that we find it increasingly unlikely that GM’s free cash flow will moderate (ex-working capital), even in a deep downturn. The most common questions from investors: 1) What’s the “real” net cost reduction? 2) What are the chances GM will be forced to reverse course? 3) What are the implications for Ford?
Our Outperform recommendation on GM was based on 2 major pillars: 1) We believed that the potential upside from GM’s AV business was too large to ignore, and; 2) We believed that investors underestimated the magnitude of positive earnings/cash flow drivers in the pipeline. GM’s restructuring plans, announced early Monday, underscored our view. And frankly, we do not believe that the magnitude is yet fully appreciated. Clients are still asking us what the “real net cost reduction number” might be. Folks, $6 bn is the “real net number”. Over the next 2-years GM believes that its fixed costs should decline by $4.5 bn, and capex should decline by $1.5 bn. There is no offsetting negative from higher EV or AV spending (within GM’s reduced cost structure, spending will be increasingly redirected towards EVs).
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