Auto stocks sputter as global pressures mount
Job losses, falling sales, emission scandals and the rise of electric vehicles have harmed sentiment towards auto stocks, which are now trading at low valuations.
Job losses, falling sales, emission scandals and the rise of electric vehicles have harmed sentiment towards auto stocks, which are now trading at low valuations.
The global car industry is facing a perfect storm in 2019. One of the industry’s most pivotal figures and head of the Renault-Nissan-Mitsubishi alliance, Carlos Ghosn, remains in jail in Japan on charges of financial misconduct. Car sales in Europe and China are falling, and the Volkswagen emissions scandal has eroded trust in carmakers.
In Australia, falling vehicle sales are a sign of broader economic malaise
Governments in many developed countries are restricting the use of diesel vehicles in big cities, while the shift of traditional carmakers to electric and hybrid vehicles demands costly investment in new production.
In Australia, falling vehicle sales are a sign of broader economic malaise driven in part by a dramatic slowing in house prices – particularly in capital cities of the east coast.
New car sales fell almost 15 per cent in December 2018, year-on-year, driven by weaker sales in each Australian state and territory, data from the Federal Chamber of Automotive Industries shows.
About 87,500 new vehicles were sold in December 2018, more than 15,000 units less than December 2017. This was down further from earlier in the quarter: 90,000 new vehicles were sold in October, from 130,000 in June.
In the same month, house prices fell by 1.8 per cent and 1.5 per cent in Sydney and Melbourne respectively. Over 2018, home prices fell 8.9 per cent and 7 per cent in these markets - declining 4.8 per cent nationally during the year.
Morningstar's Australian head of equity research, Peter Warnes, attributes falling car sales to a declining "wealth effect" linked to falling house prices.
"In isolation, the effect of the current bout of house price weakness would likely be more pronounced on economic activity and GDP growth than it currently appears,” Warnes says.
Small falls in this wealth effect – whereby people spend more because the value of their assets is rising – affect the purchase of big-ticket items, such as cars.
While Australia has no share market-listed automotive manufacturers, there are several large listed companies highly exposed to vehicle sales.
Automotive Holdings Group (ASX: AHG) is one of these, operating an automotive network selling passenger cars and commercial trucks.
In November last year, Morningstar analyst Daniel Ragonese downgraded narrow-moat AHG in part because of the threat falling house prices pose to consumer spending.
"With further deterioration in the Australian residential property market, and the consequential negative wealth effect, the health of the automotive market will likely worsen before it improves," Ragonese says.
He cut the FVE to $2.80 a share on 2 November, then reduced it further to $2.60 later in the month "as it appears we were still too optimistic," Ragonese said.
In neutral but fuel in the tank
Despite the effect of falling house prices on AHG, Ragonese continues to see upside.
The company remains undervalued, according to Morningstar's assessment, trading at $1.56 relative to its $2.60 FVE.
“New vehicle sales are cyclical, and we continue to believe sales will revert to normalised levels as the property market stabilises," he says.
Ragonese expects AHG's earnings to start recovering from fiscal 2021 onwards.
Protected by the network
Carsales.com (ASX: CAR) is another narrow-moat stock with exposure to Australian automotive sales. The company owns the dominant automotive trading platform in Australia.
Morningstar equity analyst Gareth James also acknowledges the negative wealth effect from falling property prices, but has maintained his $14.50 FVE for the stock.
"We expect Carsales’ narrow economic moat and associated network effect to protect its market share and profit margins from short-term challenges," James says.
He says weakening real estate prices will have a more muted impact on Carsales than on dealerships. Carsales has exposure to the entire pool of about 15 million passenger vehicles – both new and used – than the much smaller segment of 1.2 million new cars.
Crucially, Carsales has no automotive financing division. Such divisions were hit by the Australian Securities & Investments Commission's decision in November last year to ban “flex commissions”. The regulator feared car dealers were pushing loans on to customers who were at risk of defaulting.
"In the long run, we expect cyclical uptick in car sales following current deferral of purchases, due to the depreciating nature of the asset, rather than a structural decline in the market size," James says.
Car maintenance lifts as sales decline
Automotive parts supplier Bapcor (ASX: BAP) has a similarly broad exposure to the 15 million-strong new-and-used passenger vehicle market, which differentiates it from AHG's reliance on new car sales only.
Bapcor carries a narrow-moat rating and is moderately undervalued, trading at $6 a share versus a $7 FVE.
Ragonese says one of the company’s most attractive characteristics is that the bulk of its earnings are exposed to the automotive trade segment.
"While consumers may temporary delay major expenditure on vehicle maintenance, this cannot be avoided entirely, as the cost of engine failure would entail considerably larger cost," he says.
Indeed, he points to an increase in maintenance expenditure as new vehicle sales have declined, "as consumers opt to prolong the life of an older vehicle rather than upgrading".
Ragonese forecasts high single-digit growth for the next five years, citing its expanding trade network and its strong brand positioning in the highly fragmented segment.
