Auto Industry Booming on U.S., Europe Sales

The sustained improvement in labor market and low oil and gas prices has been driving up auto sales, thus becoming a blessing for automakers. Apart from giving a boost to already rising U.S. auto sales, it has helped in the recovery of the European auto market. A series of attractive vehicle launches have added to the pace, notwithstanding the issues surrounding the Volkswagen ( VLKAY ) debacle.

However, falling sales in China in recent months is a major concern for automakers. The large volumes of safety recalls are amplifying their problems.

Still, there are plenty of reasons to be optimistic about the broader auto industry for both the short and long term. Below, we discuss some of these key factors that should continue to drive the sector's performance momentum in the near to medium term.


Low Oil & Gas Prices Drive Vehicle Sales

Global oil and gas prices continue to remain low, despite recovering slightly from the six-and-a-half-year low reached recently. The trend is expected to continue, going by Goldman Sachs' recent cut in 2015 domestic crude estimate to $48.10 a barrel from $52.00 and 2016 forecast to $45.00 from $57.00. Moreover, the investment bank projected that crude could fall to as low as $20 per barrel, in the worst case scenario, due to global oversupply.

The low oil and gas prices are benefiting automakers significantly. As fuel becomes more affordable, sales of gasoline-powered vehicles - especially the larger ones that carry a wider profit margin - get a boost. Although sales of hybrids and electronic vehicles are suffering from this trend, the sales volume of such vehicles is significantly lower than gasoline-powered vehicles. Hence, the positive impact of low oil and gas prices outweighs the negatives for the auto sector.

Focus on Vehicle Safety Beneficial for Parts Makers

Increasing focus on the safety of vehicles is benefiting parts manufacturers, specifically those dealing with automotive safety products. For example, 10 major automakers recently agreed to offer automatic emergency braking ("AEB") systems as a standard feature in all their vehicles in the U.S. Apart from ensuring better road safety, this move will also benefit auto parts manufacturers that produce AEB systems.

Rising U.S. Auto Sales

U.S. light-vehicle sales increased 3.8% year over year to 11.6 million units in the first eight months of 2015. Sales on a seasonally adjusted annualized rate ("SAAR") basis surged to 17.81 million units in Aug 2015 from 17.3 million units in Aug 2014. The sales volume was driven by low gas price, an improving employment rate, and the easy availability of credit with lower interest rates and longer repayment periods.

U.S. light-vehicle sales increased for the fifth consecutive year in 2014, improving on the six-year high achieved in 2013. In fact, for the first time since the recession in 2008, U.S. auto sales had surpassed 16 million units in 2014. Moreover, the popularity of the more-profitable vehicle segments such as pickup trucks, utility vehicles and luxury cars surged last year, thus benefiting automakers.

The trend is expected to continue courtesy of low fuel prices and interest rates, enhanced job security, rising wages and household wealth, improving consumer confidence, residual pent-up demand, attractive deals and vehicle launches. Analysts expect U.S. light-vehicle sales to reach 7 million units this year.

Moreover, the high average age of light vehicles on U.S. roads is resulting in high replacement demand for cars as well as car parts. The average age is expected to rise to 11.5 years by 2017 and 11.7 years by 2019 from 11.4 years at the end of 2013, according to forecasts by IHS Automotive. This will benefit auto parts manufacturers and retailers.

Sustained Recovery in Europe

The recovery in the European automobile market is continuing this year with an 8.6% year-over-year passenger cars' sales increase recorded in the European Union in the first eight months, according to the European Automobile Manufacturer's Association. The increase in sales is being attributed to improvement in all major markets, including Spain, Germany, UK, France and Italy. Sales of passenger cars in the European Union turned around with a 5.7% year-over-year increase in 2014 that followed six years of decline.

Attractive Vehicle Launches

Rising sales and intense competition are driving automakers to come up with new and attractive, technologically advanced vehicles to gain market share. Most automakers are also revamping their popular vehicles by adding new technologies and enhancing their visual appeal to refresh their sales.

These companies are also offering attractive optional features in vehicles to earn higher profits. These features provide scope for surplus revenue generation from small cars, which have lower profit margins than large trucks.

Government Role in Emission Reduction

Though the much talked-about auto industry bailout is behind us, the U.S. government's role, albeit on a smaller scale, is still felt in the space. The U.S. Department of Energy (DOE) lent over $8.5 billion to a few automakers under the Advanced Technology Vehicles Manufacturing (ATVM) Incentive Program to encourage greener or more fuel-efficient cars. The aim of the program is to reduce dependence on oil, curb greenhouse gas emissions and create new jobs.

Ford utilized the $5.9 billion DOE loan to retool 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 written off by Jun 15, 2022.

In May 2013, Tesla Motors, Inc. ( TSLA ) 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 cleared its debt with an advance repayment of the entire outstanding balance.

Nissan Motor Co. Ltd. ( NSANY ) was another carmaker to benefit from the program. The company obtained a $1.4 billion ATVM loan to retool a manufacturing facility, develop a cost-competitive electric vehicle and construct one of the largest advanced battery manufacturing plants in the U.S.

Apart from this, in late 2011, 13 major automakers - Ford Motor Co. ( F ), General Motors Company ( GM ) and Toyota Motors Corp. ( TM ) 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 fuel efficiency and emission levels in the recently developed vehicles.

Bottom Line

There are several reasons to be optimistic about the auto sector's performance in the near to medium term.

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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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