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.
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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.
This AM (12/4/2018), KMX announced the rollout of its new omni-channel offering that it’s launching in Atlanta. KMX plans for it to be available to a majority of its customers by Feb. 2020. In its FQ2 call, KMX said that it would bring this experience to a major metro market by year end; however, it did not name the market nor signal a timeline for a broader roll-out.
We came away from Carvana’s Investor Day with reinforced conviction in our Outperform rating and 3 key takeaways: 1) The company’s competitive advantages (structural, technological, and cultural) are larger than perceived; 2) The market opportunity is massive, and; 3) The business model has clear opportunities for significant margin expansion.
We think the used car industry is at an inflection point in online adoption driven by Carvana which has reinvented the used car experience with a better mousetrap. CVNA is hosting its inaugural analyst day on 11/29 and we believe the event will be a catalyst that removes opacity from the long-term margin outlook and demonstrates the superiority of CVNA’s business model to a larger set of institutional investors.
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).
Yesterday AMC (11/07/18), CVNA reported Q3 results. Retail Units sold grew 116% beating Cons by 2% and Total $GP/Unit of $2,302 met Cons. Importantly, the Q4 retail unit guide was both above Cons and slightly above the implied guide from Q3. Implied Q4 Opex guidance was slightly higher than expected. Given this is a unit driven story, we believe the tremendous topline growth coupled with a positive Q4 guide and strong Retail $GP/U’s will alleviate recent investor jitters on bottlenecks.
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 are initiating on CVNA shares with a $78 CY 2019 Price Target derived using a 10-YR DCF with long-term assumptions backed by our blue-sky financial model. This price target embeds a 1.8x NTM EV/Sales multiple versus the company’s current 2.7x multiple. As longterm believers in the CVNA productivity model, we have developed a 3-step plan from which to frame the opportunity in CVNA shares.
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