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.
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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:
Fiat Chrysler posted an in-line quarter Tuesday morning (10/30/18), with adjusted EBIT of €1.955 vs. WRe €1.933 bn. Once again, the results were exceptionally strong in North America (€1.937 bn/10.2% margin—this is where all of the money is made), but weak in APAC (losses), EMEA (losses), and Maserati (very slight profit). 2018 EBIT guidance was maintained at €7.5-8.0 bn (exp. low end), but free cash flow guidance came down (now €3.8 bn due to a drag from working capital and a pension contribution, offset by deferral of capex).
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.
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%.
But interestingly, we’ve noted significant declines for certain key commodities over the past few months. Aluminum, which represents around 20% of the average vehicle’s raw material costs, is down 20% off the April peak, and down 11% since June. Copper makes up 7% of raw material cost and is down 15% since June. Steel accounts for around 50% of total Raw Material cost. And here too, we are starting to see some moderation, as U.S. HRC and CRC prices are down around 7% since peaking in July. And expectations are for Steel prices to decline further in 4Q18 and 2019 as capacity utilization at U.S. mills remains low (around 70% currently).
Given media reporting on this transaction over the past few weeks this should not come as a surprise. And this may not change Investors’ sentiment in the near term. But we nonetheless view this as a very positive development—especially relative to FCA’s €21 bn market cap, and the relatively low valuations that have been ascribed to FCA’s non-core assets (based on public supplier multiples we have been incorporating just €3 bn proceeds into our model; every €1 bn upside should, in theory, be worth ~€0.64 for FCA). If nothing else, the improvement to FCA’s balance sheet (on top of €15 bn cash that we projected for YE2018) should lay to bed any remaining questions about this company’s ability to withstand a major downturn: FCA estimated that a 30% global downturn could reduce FCF by €11 bn (€6 bn reduction to EBIT and €5 bn from working capital); a 30% North American downturn would reduce FCF by €7 bn (€4 bn decline in EBIT and €3 bn from working capital).
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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