The car industry is the epicenter of the current economic slowdown. The car business is both the culprit and a victim of the biggest economic downturn since the Crisis. It is not just in Germany, but also in Asia and Detroit. The industry uses so many raw materials and supplies from many adjacent industries, that the contraction in the auto sector is is dragging the whole global economy down with it. The chief executive of VW says “This trade war is really influencing the mood of the customers, and it has the chance to really disrupt the world economy … Because of the trade war, the car market [in China] is basically in a recession . . . That’s scary for us”.
FINSUM: What is curious about the car downturn is that consumers are very strong. Therefore, from our view, the weakness in the auto sector is more concerning because it could be a leading indicator.
By all accounts, the US car industry should be doing well. Vehicles sales have been good, unemployment is low, and gas is cheap. However, US car companies are closing factories and laying off workers and acting like we are in a big recession. Why? The answer is that their product mix and manufacturing capabilities are seriously out of touch with the market. In particular, they have far too much sedan manufacturing infrastructure in a market that no longer has much use for sedans. This is a huge problem because overcapacity is what doomed car companies in the last recession.
FINSUM: The good thing here is that the car companies are trying to be proactive in adjusting their facilities ahead of a broader downturn. However, closing factories and laying off workers following such a good run is getting a lot of negative political attention.
You might not think it is the right time for this stock, but Goldman Sachs says you should. The bank has just come out very positive on Ford. The automotive company has far outpaced the S&P 500 this year, but is still down 16% over the last 12 months. Goldman says that Wall Street is not appreciating how significant Ford’s recent restructuring is, as they think it can unlock “billions in trapped value” by lowering costs in the trucks division.
FINSUM: Basically, Goldman says Ford is going to see a big and sustained pop in earnings that no one sees coming. It is a nice, simple thesis and we like it.
Will the robotaxi model come to dominate the car landscape or will the current ownership model persist? Will electric cars come to dominate? These are big questions for the US automotive industry. However, the answer is that it likely won’t matter because Detroit will win either way, especially GM. While Tesla would have no backup plan if electric cars didn’t become mainstream, GM could continue on with its main business line. Further, GM has a valuable self-driving card division, Cruise, which could do very well if robo taxis become the predominant model.
FINSUM: A couple things to note here. Firstly, GM is the cheapest stock in the S&P 500 on an earning basis, so it has a lot of upside. Secondly, we don’t think the robo taxi model will take over as the cost per mile to the end consumer is likely 2-7x the current cost, which means there would need to be massive changes to make it competitive.
Investors looking at the automotive sector need to think carefully about their allocation. In particular, it might be smarter to put money into automakers themselves, like GM and Ford, rather than parts suppliers. This runs counter to the typical investment strategy of buying into suppliers in major industries rather than producers themselves. Parts maker in autos have outperformed makers over the last several years, but there is a big catalyst for a reversal: auto makers are no longer looking to slash prices to increase volume. Instead, they are shifting to a higher priced margin-oriented model, which favors the makers’ stocks versus suppliers’.
FINSUM: We think the concept of a higher margin business favoring makers is logical.. However, we aren’t sure the customer is actually going to buy into this model, in which case neither makers nor suppliers would do well.