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The Auto Sector's Next Turn: The Market Guide

by Daniel Shvartsman

As we roll through Q1 earnings, we're shining the spotlight on the auto sector. In the past 10 days, Ford (F), General Motors (GM), Fiat Chrysler (FCAU), and Tesla (TSLA) have all reported earnings. We're in the backdrop of a market near all-time highs but with US vehicle sales at about the same cyclical high (plateau?) they've been at since late 2015. For the big 3, are there any signs of a change? And for Tesla, well, in between when we asked these questions on Wednesday and received answers on Friday, they announced a capital raise. So it's been a busy week as usual for the California electric vehicle maker and lightning rod.

Welcome to The Market Guide! This weekly newsletter features our Marketplace authors zeroing in on one of the hot topics of the week. The Marketplace is our platform for authors to run services that provide research, guidance, and ideas to investors, and to lead investing communities. So we thought this newsletter would be a natural way to share some of those ideas and guidance on specific topics. We'll also highlight related articles and must-reads from our authors over the past week, and any developments on the Marketplace as a whole. Here's last week's edition for reference.

Our panel this week:

  • Bram de Haas, author of Special Situation Report
  • Arturo Neto, CFA, author of The Income Strategist
  • Anton Wahlman, author of Auto Insight for Wall St.

Ford's report appears to have marked a turn in the road - North America shined, the restructuring in Europe is getting clearer, and Jim Hackett's plan is starting to translate into results. Are you buying that this is a turnaround, and what do you think about the stock?

Arturo Neto: I like Ford more for its market share on Trucks in the US. Any progress it makes outside of the US is just icing on the cake as I see it. If you look at the trends in domestic car sales versus domestic truck sales, they are going in opposite directions. While total vehicle sales have been rangebound, the breakdown of those sales between trucks and cars has shifted dramatically with Trucks gaining momentum. Looking out even longer, it seems to me there is less and less motivation for the younger generations to drive, much less buy cars. They are more likely to use ride-sharing services or scooters or walking. That is not the case with trucks. Truck buyers don't buy them to get from point A to point B as much as they do for deliveries, camping, towing, home improvement projects, etc. Those aren't activities that can be easily replaced by a ride-sharing option.

As for foreign competition, it is intense in the auto sector but not so much among trucks. A Cox Automotive report indicated that 71% of full-size truck buyers prefer the truck's brand to be headquartered domestically, which means there is likely to be less foreign competition in the space as well, especially in the full-size segment. The customer loyalty towards the F-150 is ridiculously sticky and the reintroduction of the Ranger and Bronco could bring back additional customers. The stock has been recovering from a multi-year low and at a dividend yield of 5.8% and a 77% payout ratio, I think it's a good hold for income-seeking investors as well.

Anton Wahlman: Ford benefited from very low expectations, but it is also becoming clear that the new products that are coming online over the next 6-18 months could be really good: Explorer, Escape, and that all-electric crossover. The first two, in particular, are Ford's best-selling non-pickup trucks. What you have to realize, however, is that those were all frozen and set in motion already before Jim Hackett took office two years ago. They will launch on his watch, but they were not conceived on his watch.

GM didn't get quite the same response: reduced income from China and increased competition from Fiat in the pickup space are two potential sources of souring sentiment. How does this quarter fit into your outlook for the company?

Bram de Haas: To me it seems the sentiment around General Motors has never been very cheerful over the last few years. Here's this $54 billion company with cash flow from automotive operations of about $12 billion(projected for 2019). Free cash flow will likely be something like half that. I think CapEx is elevated. That's great in this market. What people don't realize is that Cruise, majority owned by GM, is a leader in autonomous. It is throwing a billion a year at this segment and there are no returns yet. Both SoftBank (SFTBY) and Honda (HMC) are external investors which put the value of GM's stake at something like $11 billion. GM lagged the S&P 500 slightly year-to-date but since I've written it up in the Special Situations Report it outperformed both the S&P and First Trust NASDAQ Global Auto Index ETF (CARZ) by a wide margin. I also mentioned the possibility of shorting CARZ against GM because of the prevalent trade tariff concerns at the time. That would have worked out great.

Anton Wahlman: GM suffered from higher expectations than Ford, given all the progress in 2018 coming from the various deals with Softbank and Honda, as well as investments in Cruise and LYFT (LYFT). That alone set the bar far higher than Ford. However, GM's pickup truck product simply isn't performing as well as FCA's RAM or Ford's F-series. There is widespread disappointment among journalists about the Chevrolet Silverado and GMC Sierra, at least in their "1500" half-ton duty versions, that just aren't quite competitive with their two main competitors. Just look at the interior of those products, and you can probably figure out at least half the reason.

Fiat has featured in a lot of M&A discussion and has as mentioned targeted GM in the pickup segment. What do you make of their report and their position amidst the big 3?

Bram de Haas: GM CEO Mary Barra has quietly done at least an excellent job. Unprofitable overseas segments were divested or restructured. An investment in Lyft doubled in value so far. The U.S. is being prepared to weather a downturn in the auto cycle. Management is really on the ball. My only gripe is they could have been more aggressive with buybacks. Barra rebuffed late Fiat Chairman Sergio Marchionne and looks like an able capital allocator, not an empire builder. In addition, she's been born and raised in a GM family. Probabilities General Motors will merge with Fiat are extremely low.

Anton Wahlman: Fiat benefits from low expectations in general, and especially following the disappointing guidance last quarter, when the stock traded down significantly in its initial reaction. This time, there was relief simply from the stabilization that came from reaffirming the full-year guidance, but also management's detailed explanation of its plan to meet European emissions compliance with new products -- as opposed to having to purchase more credits, whether from Tesla or anyone else.

No preamble for Tesla - what do you make of Q1 and recent developments, and what happens next?

Bram de Haas: Tesla is raising a $700 million of equity and almost double that through convertible bonds. This is a vital step it should have taken earlier. The fact that Tesla did not has been the main reason I'm short. We still have to see at what terms Tesla is raising money. How dilutive is it going to be? How painful will the coupon on the converts be? Who's buying in? If it goes well for Tesla I could be out of the short.

Anton Wahlman: The news of the week is clearly the successful capital raise, which buys the company probably a year's worth of breathing room, after having been on the brink. This despite the management selling the deal on the basis of something that I believe simply won't happen -- Level 5 (full) autonomy by 2020. It will obviously come back to bite the company in the rear, but for now, it helps the company in 2019 by not teetering on insolvency. That brings us back the real performance of the business: Sales in April were very bad from what we can tell from most countries, and the company has a steep hill to climb in order to come even close to making the June quarter guidance of selling 90,000 to 100,000 cars.

Last question - auto sales have been on the high end of their cyclical level, and in a holding pattern since late 2015, according to FRED's data. In light of Q1 reports, what would you tell investors about where we are in the cycle?

Anton Wahlman: I am bearish on the industry fundamentals, as I believe profit headwinds come from cost of emissions compliance and other political requirements to source locally, which impact cost all-around, whether from tariffs or from diminished scale if you try to work around the tariffs. This makes the automotive sector one of the worst imaginable right now. That said, the valuations of General Motors, FCA and Ford are very low, and they already discount much or even all of this. If there is any regulatory relief, especially on emissions laws or even in terms of tariffs and local sourcing, then these stocks would see higher profits and rally accordingly.

Editor's Note: Please see disclosures for these authors at the end of the article.

What To Know About Beyond Meat Before Its IPO by David Trainer

IPO Update: Beyond Meat Prepares For $175 Million IPO by Donovan Jones

A reminder that 'tech' companies can operate in other sectors (and earn crazy multiples still), Beyond Meat (BYND) went public this week and soared higher. David Trainer of Value Investing 2.0 and Donovan Jones of IPO Edge provide some background for anyone looking at it after its prodigious pop.

Microsoft's Strong Results May Push Shares Even Higher by Mott Capital Management

Microsoft: Surprisingly Steady Growth by Michael Wiggins de Oliveira

As Microsoft (MSFT) gets the hype for becoming the most valuable company in the world, two Marketplace authors review their recent earnings report. Both Mott Capital Management of Reading the Markets and Michael Wiggins de Oliveira of Deep Value Returns like what they see.

General Electric's Crown Jewel Leads The Charge by Daniel Jones

GE: Deciphering Q1 Results by Robert Honeywill

General Electric Improving: Shares Likely To Move Higher From Here by Victor Dergunov

And fresh off of last week's review of the industrial sector, General Electric (GE) came out with a positive earnings release, at least per the market. Victor Dergunov of Albright Investment Group liked the earnings beat, while Daniel Jones of Crude Value Insights focused on the aviation segment. Robert Honeywill of Analysts Cnr | H2 Supergrid, meanwhile, highlights how this report was actually more in line with expectations that has been reported.

Berkshire Hathaway's True Moat by Eric Nickolaison

Lastly, in light of today's Berkshire Hathaway (BRK.B) (BRK.A) meeting, here's an article from Eric Nickolaison of Wide-Moat Investing Platform about Berkshire's biggest moat, which may be playing out with its involvement in the Occidental (OXY) bid for Anadarko (APC).

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We launched two new services this week that you may be interested in. First is Daniel Schönberger's Moats & Long-Term Investing. And launch is the appropriate word for Cestrian Capital Research's new service, Invest In The Space Race. Check out their launch articles:

  • Launching Moats & Long-Term Investing
  • Welcome To 'Invest In The New Space Race' With Cestrian Capital Research

We also posted our Fastest Marketplace Climbers For April 2019 list for anyone interested in seeing the movers and shakers on the Marketplace last month.

Our Roundtable podcast features 30-45 minute interviews with Marketplace authors about investing strategies, their background, and development in investing, and current ideas or market views of interest. We featured one podcast this week:

Eric Basmajian of EPB Macro Research spoke with Jonathan Liss about the burden of debt on the global economy and the impact it'd have on world markets - low growth, low rates, and how to invest amidst that.

Listen and subscribe to the Marketplace Roundtable on these podcast platforms:

  • iTunes/Apple Podcasts
  • Spotify
  • Stitcher

Thanks for reading! Are you buying or selling the auto industry? Let us know below.

See also Melco: Lawrence Ho's Global Reach Is The Reason To Hold Now, But Jump In Later This Year on seekingalpha.com

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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