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.
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).
AXL reported their Q3 on Friday morning (11/02/18)… and they missed badly, as Q3 EBITDA fell $40 MM short of our estimate (EBITDA $275MM vs. WRe $315MM and 3Q17 of $298MM). AXL’s Q3 EBITDA margin fell to 15% vs. expectations of 17%+. Clearly, investors’ confidence was badly shaken. Ours was too, as all external checks did not provide any clues that this company was going to miss. AXL’s shares fell 27%.
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.
We’ve met with a broad cross-section of clients since our launch on October 1 and thought it worthwhile to relay some of the feedback. There is broad agreement with our Underweight rating on the core Autos sector, driven largely by affordability concerns in the US which led us to forecast a 1.0-million-unit decline in US volumes. The Auto sector has historically underperformed 70% of the time during peak-to-trend phases.
We’ve been bracing for a tough Q3 earnings season. European Auto production, China Production, and FX headwinds all intensified over the course of the quarter. We’ve been expecting misses/guidance revisions from number of companies in our Universe (Based on the company’s business model and regional profile, Delphi struck us as the most at risk prior to Friday’s pre-announcement). But we’d note that the risks are not equal. BWA already adjusted guidance at their CMD. AXL may even have upside. Our analysis also suggests surprisingly benign results/guidance from LEA, DAN, MGA, and APTV. On the other hand, consensus for GM, F, GT, CTB, ALV, VC, and VNE may require downward adjustments.
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