Market sector report - Should you invest in the car industry?
09:23, 16 May 2017
Henry Ford’s dictum ‘any colour so long as it is black’ couldn’t be further than the truth in the 21st century. You can buy a new car in a near infinite range of trims, colours and drivetrains – including electric power.
Yet it’s an industry under huge regulatory pressure as politicians and bureaucrats bear down on polluting vehicles and safety, paving the way for autonomous and driverless alternatives.
The old way of buying a car is also changing as renting or leasing becomes easier and more socially acceptable. So where should you invest in the car industry – should you invest? – and what should you watch for?
Four automotive industry trends to watch
- Car maker share prices increasingly vulnerable to global trade tariffs, environmental taxes and R&D ratios
- New technology brings higher levels of fraud risk – think VW’s software ‘dieselgate' scandal –and hacking
- Long-term cost of capital is unlikely to dip further from current historical lows putting more pressure on future capital outlay
- Internet buying means increasing pressure on sales margins while PCP buying is a structural change
Four financial facts
- 5.5% – the average total shareholder return from automakers between 2012–2016 compared to 14.8% from the US S&P 500 in the same period (PWC)
- £20,900 – the average value of a car exported from the UK in 2016 (The Society of Motor Manufacturers & Traders)
- 20% – the estimated value of electronics in the cost of a car 2017-2019 compared to 13% in 2015 (PWC)
- 4% – the proportion of GDP the UK car industry contributes to (Bank of England)
What affects the automotive market share prices?
Automotive industry market share prices can be hit – from natural disasters to ill-advised tweets – in as many ways as there are different marques. In January 2017 President Trump tweeted that tariffs for Mexican-built Toyotas could be introduced to protect the US car industry.
“Build plant in US or pay big border tax,” he said. Trump’s utterance wiped $1.2bn in value from the Japanese car manufacturer within a few minutes – a 3% share price fall.
Between 2009 and 2010 Toyota was hit by several recalls, including an allegation of unintended acceleration related to the front driver’s foot pedal mat, plus software glitches.
- Sales of the Camry, Toyota’s US best seller for seven years, crashed 20% in February 2010
- Toyota’s stock price plunged even lower: between 21 January and 4 February of the same year Toyota’s share price sank 22% or $30bn
- Its reputation for building reliable, durable vehicles was hammered
But the most notorious shock for investors was Volkswagen in 2015. VW’s share price plummeted more than 63% between 10 April and 2 October 2015 – from €253.20 to €92.36 – after chief executive officer Martin Winterkorn admitted the company cheated on US air pollution tests.
Step away from media headlines and the mundane – but vital – issues of rising (or falling) raw material costs, R&D and labour costs hove into view, impacting every-day share price movements.
What can make one company buck the trend?
Much of it comes down to long-term strategy, planning and being able to differentiate a brand. Building up emerging markets exposure quickly and smartly helps – a lot.
“Let’s say you’re looking at the future,” says Ruth Bender, Professor of Corporate Financial Strategy at Cranfield School of Management, “and you have a car manufacturer that is selling into Western Europe and another car manufacturer that’s selling into China or Asia.
"All things being equal you would expect the one selling into Asia to have a higher share price because of greater potential growth in the future.”
- Exposure to growth markets can increase sales
- Higher profit margins can lead to a higher return on capital employed
- The danger, says Bender, "is that a desire to up profits might lead to short-term actions such as cutting R&D, damaging company and industry prospects"
Brand differentiation is increasingly tough given increasing amounts of platform sharing. US-based Morningstar senior equity analyst Richard Hilgert warns the industry has now become so efficient that genuine differentiation anywhere is rare.
Toyota he says was the leader in the 1970’s “though their lead has diminished as the auto industry widely adopted statistical analysis, continuous process improvement, and other lean manufacturing disciplines. Innovation,” Hilgert goes on, “enables higher quality, productivity, and improved returns on invested capital. However, these competitive advantages are quickly competed away.”
What can make a company's share price fall?
The savage Japanese tsunami on 11 March 2011 – killing almost 16,000 Japanese citizens in total – could not be reasonably anticipated.
This natural disaster caused huge supply chain disruption for major Japanese car manufacturers: shares in Nissan, Toyota and Honda fell 9.5%, 7.9% and 6.5% respectively. Suppliers big and small embedded across the industry suffered hugely.
Future emission regulations, subsidies and punitive fines, fair or unfair, also hang over share values. Some of these can be planned for. However the future of diesel cars looks very difficult, and the stakes are high:
- 49.5% of all new passenger cars registered in Western Europe ran on diesel
- 45.8% on petrol, according to the European Automobile Manufacturers Association
- 2.1% sales came from hybrid electric vehicles
As recently as April 2017, Daimler AG’s Mercedes-Benz US chief Dietmar Exler could not tell the automotive press if the German car giant would still sell diesel vehicles in the US (dependent on US Environmental Protection Agency approval).
In early April BMW’s share price dipped nearly 3.5% to €82.63 after EU internal market industry commissioner Elżbieta Bieńkowska confirmed diesel cars will be hit by tough new EU rules.
Manufacturers will face fines of up to €30,000 per vehicle if they’re caught cheating.
“Diesel will not disappear from one day to another,” she said. “But I am quite sure they will disappear much faster than we can imagine.” BMW’s share price remains more than 25% down at €89 compared to early 2015.
So a lot of uncertainty and the possibility of fresh share price falls. For now an uneasy ‘crossover’ period exists as diesel sales retreat and the pace of electrification and plug-ins pick up.
Oil prices still affect car sales (and profits) but are also linked to tax treatment and different consumer markets. An oil price slip will have less impact for heavily taxed Scandinavian car users than for US motorists. So a complex picture with many, many strands.
What should I look out for in company accounts?
Focus on profits and the journey to that goal says Professor Bender.
- "Broadly it’s about how much profit a car manufacturer will make and how much cash is needed to generate it [profits]"
- "For car makers there's the capital spend for fixed assets to be bought, replenishing plant – upgrading robots, for example – and the amount of R&D needed as well as how much inventory is tied up in old stock or vehicles they’ve made to keep their factories going”
- A smart R&D department makes a lot of difference. “If R&D generates great products from less investment it’s obviously a lot better than spending R&D and not bringing to market anything that wonderful”
Bender warns on outstanding litigation that have to be settled. “VW haven’t settled all the liabilities for the emissions scandal, so that would concern me.” These costs continue to rise.
Morningstar analyst Richard Hilgert advises looking for companies with clear economic ‘moats’ and the chance to buy shares at discount.
“While wide-moat-rated Ferrari was a perfect example last year, its stock price has doubled, resulting in a star rating that went from four a year ago to one today."
He went on: "However, we think narrow-moat four-star rated BMW shares, currently trading at better than a 15% discount to our €107 fair value estimate, offers investors an attractive value."
What else is there to watch out for?
Delivering on technology matters. Almost every car manufacturer wants a next-gen electric vehicle (EV) on sale by 2020, from Jaguar to Skoda to Porsche.
Tesla though has electric cars on sale now. With a market capitalisation of around $49bn – bigger than Ford’s $44bn – the EV tech company’s share price has had a wild ride from $30 to $293 (early May 2017).
In the last six months Tesla’s share price has surged 50%. Tesla is readying its new mid-market Model 3 for a July 2017 launch but investors will be looking keenly at delivery guidance from Tesla for the second half of the year – which won’t happen till midsummer.
Other factors to consider:
- New US tax cuts may boost car sales in the US short-term
- President Trump is intent on scrapping Democrat Party fuel economy targets – ex President Obama wanted new cars to average 54.5mpg by 2025 – which, long-term, however could make US car makers less competitive
- Capital investestment for 'connected technology' is not cheap - many electronic components will remain expensive, exerting pressure on profits
- Expensive safety and environmental regulation can only increase
- Distribution costs (and profits) may change as web buying becomes more widespread
Markets in this article
Volkswagen AG (Pfd)