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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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.
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:
Once a quarter, we comb through corporate filings and summarize the most noteworthy datapoints. At a high level, developments during the quarter reinforced our view that investors should be Underweight Autos and Auto Parts, Underweight Dealers, and Overweight a relatively small selection of companies that fall into the Auto 2.0 category. In our view the U.S. Auto Cycle is in its 8th or 9th inning, with looming pressures on vehicle affordability. China is experiencing its first real Auto Industry downturn, and we are not convinced that the Central Government will step in to specifically prop up Autos. Europe also faces a number of challenges: These include potential trade risks (7% of Europe produced vehicles are exported to the U.S.), political risks (Brexit), and regulatory risks (vehicles more expensive to produce, at the same time that pricing has become more challenged).
Bloomberg reported overnight that China’s National Development and Reform Commission is considering reducing the Vehicle Purchase Tax to 5% from 10% on vehicles with <1.6 liter engines (approx. 70% of market). While we don’t believe China’s Central Government wants to do this (as we’ve noted before, we believe automaker consolidation is desired and broad-based stimulus helps the entire market), the consumer may have painted the government into a corner with September retail sales down 13% and first 3 weeks October down 25%. Today’s story probably makes consumers even more reluctant to buy in front of a tax cut, adding more pressure to act; therefore we believe the stimulus is likely to happen.
The magnitude of the changes, disclosed on the earnings call early Thurs., shook our confidence a bit. We are lowering our 2018 / 2019 / 2020 EPS estimates to $17.80 / $18.46 / $21.55 from $18.80 / $21.15 / $24.34. Nonetheless, if it is able to achieve the Free Cash Flow that we anticipate (around $1.0 bn in 2019), we believe LEA should be a relative Outperformer within a challenging space.
China’s Auto Industry has been on an impressive ascent due to the growing middle class for the past 10+ years. This market was sustained through the global financial crisis. And it has grown through more recent challenges (including a 40% China Equity Market Correction in 2015). But as we have discussed in several reports, there is once again major uncertainty about the outlook for this market. After rising 5% during the first 5-months of this year, the retail sales market has fallen by 3%, 6%, 7%, and 13% in June, July, August, and September. Yesterday the CPCA reported a 23% decline for the 3rd week of October, bringing the month to-date to -25%.
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