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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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).
Visteon reported 3Q18 adj. EPS of $1.12 before market open today, above WRe of $1.06 and slightly below cons. of $1.14. Adjusted EBITDA of $71mln was in-line. The path becomes more difficult, though, as the company cut FY2018 guidance for revenue by 5%, EBITDA by 8.5%, and FCF by 45%. Organic growth has taken a step-down to -9% in 2H18 (vs -5% in 1H18). Implied EBITDA margin in 4Q18 is 9.4%, down 380bp’s YOY. The stock traded down 1.7%, underperforming the auto sector by approx. 5 pts.
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%.
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.
We are initiating coverage of Visteon with a Peer Perform rating and YE 2019 price target of $105, equating to 11.0x 2020 P/E, 7.3x 2020 EV/EBITDA, and ~7% 2020 FCF yield. This is an interesting company, and management has done a very good job positioning the company as a pure-play on cockpit electronics, including infotainment and human/machine interface. However, we believe the market will continue to focus more on near-term headwinds than the secular growth profile which is largely back-dated in the forecast period. We see the likelihood for a better entry point down the road.
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