Should You Buy Auto Industry Stocks Now?

Should You Buy Auto Industry Stocks Now?

The automatic industry has come a long way since the global financial crisis threatened the existence of some of the key industry players. Sales have bounced back and remain very strong, particularly in the domestic market. However, many are starting to grow worried about several key foreign markets, as European sales could slow if their financial woes intensify.

Still, there are plenty of reasons to be optimistic about the broader auto industry for both the short and the long term. Below, we discuss some of these key reasons and what investors in the auto sector can look forward to seeing in the coming months and years:

OPPORTUNITIES

Automakers are developing technologically advanced and economically viable vehicles that cater to consumers in both mature and emerging markets to boost sales. These companies are also striving to provide attractive optional features in vehicles in order to draw buyers. These features provide scope for additional revenue generation from small cars, which have lower profit margins relative to large trucks.

Automakers also continue to shift production facilities from high-cost regions such as North America and the European Union to low-cost regions such as China, India and South America to reduce cost of production. Consequently, China is expected to account for 50% of growth in auto production over the next 7 years, according to the research by IHS Automotive.

Apart from individual company strategies, government policies in different countries about energy and the environment policies will play pivotal roles in shaping the future of the global auto industry. For instance, in late 2011, 13 major automakers, including Ford Motor Co. (F Analyst Report), General Motors, and Toyota (TM Analyst Report) to name a few, signed letters of commitment with the U.S. government to upgrade fuel economy in cars and light-duty trucks to 54.5 miles per gallon (mpg) by 2025. This has significantly improved the car designs, though at the price of higher cost.

U.S. Auto Market Remains Strong

The robust U.S. auto market is providing ample growth opportunities for automakers. Sales in the U.S. grew 8% to a 6-year high of 15.6 million vehicles in 2013. Further, it increased 5% year over year to 11.2 million in the first 8 months of 2014. In fact, for the first time since Jul 2006, sales on a seasonally adjusted annualized rate (SAAR) basis, reached the 17 million mark this June. It increased to 17.5 million units in August and is expected to around that level in September as well.
 
There are many factors leading to this improvement. The average age of light vehicles on U.S. roads reached an all-time high of 11.4 years in Aug 2013 and is still at that level. The high average age is resulting in high replacement demand for cars as well as car parts. It is expected to rise to 11.5 years by 2017 and 11.7 years by 2019, according to forecasts by IHS Automotive.

Moreover, with an improvement in the general economic situation, banks are offering more car loans with lower interest rates and longer repayment periods. The availability of car loans plays an important role in increasing U.S. car sales. In fact, for the first time since the recession in 2008, U.S. auto sales are expected to surpass 16 million units in 2014.

High Growth Prospects in Asia

Asian countries, especially China and India, are expected to account for a large portion of growth in the auto industry over the next 5 to 7 years. China is the biggest and fastest growing auto market in the world in terms of the number of vehicles sold. Not only was it the first country to surpass the 20 million unit domestic auto sales benchmark in 2013, but auto sales in China increased 8.2% year over year to 13.3 million units in the first 7 months of 2014, per the China Association of Automobile Manufacturers (CAAM).

To tap the growing Chinese market, Ford plans to triple its line-up in the nation with 15 new or revamped vehicles by 2015 and it has already seen success as China sales boosted F’s sales by 49% in 2013. The improvement continued in 2014, with a 33% increase in sales to 640,031 vehicles in the first 7 months of the year.

Ford expects the Asia-Pacific region (mainly China and India) to account for 60–70% of its global growth in this decade and generate 40% of its vehicle sales in the coming 4 to 5 years. The company expects its global sales to increase 50% to 8 million vehicles by 2015 on the back of the growth potential in Asia and the rising demand for small cars.

Meanwhile, General Motors and its joint venture partners in China plan to invest $12 billion in the domestic market by 2017. Further, the company intends to launch 60 new or refreshed vehicles in China between 2014 and 2018 and 11 new utility vehicles over the next 5 years. It is also building 4 new plants in China, and triple the exports from the nation by 2015 in an effort to sell 33-35 million units annually in the country by the end of the decade.

Even Tesla Motors, Inc. (TSLA Analyst Report) is seeking a share in the lucrative Chinese market. The company started delivering its Model S in China in April and plans to establish new stores, service centers and a Supercharger network in the nation to go along with its plans to have 10-12 stores by the end of the year.

In fact, the company recently signed a deal with China Unicom (CHU Analyst Report) to develop a network of charging stations that will eventually include 400 stations across CHU stores in 120 cities, while they will also build supercharger stations in 20 Chinese cities as well. This should definitely help Tesla in their goal to have China account for 30–35% of its global sales growth in 2014.

Financial Flexibility

Though the much-discussed auto industry bailout is behind us, the government is still somewhat involved in the auto industry, particularly in an attempt to spur greener or more fuel efficient cars.

The U.S. Department of Energy (DOE) lent more than $8.5 billion to a few automakers under the Advanced Technology Vehicles Manufacturing Incentive Program in order to reduce dependence on oil, curb greenhouse gas emissions and to create new jobs.

Ford utilized the DOE loan for retooling two plants to produce small cars and develop fuel-efficient vehicles like Ford Focus EV and C-Max Energi plug-in hybrid. The automaker is repaying the loan in equal quarterly installments of $148 million and the full amount is expected to be repaid by Jun 15, 2022.

In May 2013, Tesla became the first DOE loan recipient ($465 million) to repay the full amount. Although the loan was repayable in quarterly installments till Dec 2017, the electric vehicle maker made an advance repayment of the entire outstanding balance using the proceeds from a common stock issue and convertible senior note offering.

Repayment of bailout funds is enhancing the financial flexibility and credit worthiness of these companies. The decline in debt will allow the companies to invest freely in growth opportunities.

Bottom Line

As you can see, there are plenty of reasons to be optimistic about the auto industry for the long haul. But what about investing in the space right now?

Check out our latest Auto Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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