Automotive: Getting closer
The car manufacturing industry has been on an uptrend over the past year (FactSet World Motor Vehicle Index rose 5.7% year-to-date (YtD) and +13.1% year-on-year (YoY)). The sector is also reasonably valued compared to its ten-year average (barring FY08–FY09 crisis years) with 0.5x Price/Sales (P/S) and 1.2x Price/Book Value (P/BV) for FY17E (vs. 0.5x and 1.4x). However, the sector lags global suppliers’ performance (FactSet World Auto Parts OEM Index is up 10.6% YTD and 15.9% YoY). This is not unusual as car manufacturers underperformed suppliers in seven of the past ten calendar years. While the underperformance has been widespread across regions, the divergence has been particularly noticeable in Europe (+6.3% vs. +19.0% YtD and +13.5% vs. +16.4% YoY). Suppliers have a ~45% valuation premium to auto manufacturers in FY17E, well above the ten-year average (~15%). This is justified in our view given a larger scope for margin expansion, earnings growth and increasing return on equity relative to car manufacturers.
Vehicles demand growth has been on a steady pace of recovery since the 2008–09 crisis. 2016 marked the seventh consecutive year of growth with new vehicle sales rising 4.7% globally to 93.6 mn, including 4.8% growth for passenger cars to 69.5 mn (source: International Organization of Motor Vehicle Manufacturers (OICA)). It brings the 2010–16 average annual growth rate to 5.3% (passenger cars +4.9%). Global vehicle demand for FY17 is expected to grow further, but at a slower pace (1 to 3%). Asian demand should be the main growth engine. Russian and Brazilian demand should not deteriorate further, while demand from developed markets is expected to stall (Europe +1%, North America and Japan +0%).
Motorisation rate is high in developed countries: around 670 vehicles per 1 000 inhabitants in North America (325 mn vehicles in use), 609 in Japan (77 mn) and 579 in Western Europe (303 mn) vs. 182 globally (1 282 mn), according to the OICA. Nonetheless, replacement demand in mature markets should be supportive: the average age of a vehicle is estimated around 11.6 years in the US, 10.7 in Europe and 8.2 in Japan (source: IHS Markit, an information and analytics company). Additionally, the stricter regulatory framework on greenhouse gas emissions and safety requirements could speed up replacement demand for vehicles with internal combustion engine by more efficient and environmental-friendly ones. Looking ahead, we also believe that the replacement cycle will be shortened thanks to the fast development of cars’ technological content.
Overall, we see opportunities for car manufacturers and suppliers in particular. We anticipate car manufacturers to increase outsourcing to suppliers. This would not only be a source of higher revenues, but would also provide suppliers with greater pricing power. We believe suppliers have the potential for higher revenues and margins, despite expectations of a significant rise in research and development (R&D) spending in coming years. Car manufacturers should also benefit from solid volumes and a better mix. However we doubt that rising R&D costs (due to higher regulation) will be fully passed on to customer and we see therefore more limited margin potential.
At this stage it is not clear how the relationship between manufacturers and suppliers will evolve. However, we believe there will be a higher degree of collaboration in the years ahead. In our view exposure on both car manufacturers and suppliers will be beneficial. When looking at car manufacturer we privilege Renault (mass market, Europe centric with exposure to Asia, Russia and Latin America), Nissan (mass market, focus on North America and Japan, exposure to Asia) and Daimler (premium cars, exposure to trucks, global exposure). Meanwhile, suppliers such as Continental (automotive supplier and tyres, global exposure), Valeo (automotive supplier, global exposure) and Bridgestone (tyres, focus on North America and Japan) retain our preference. In our view, this stock selection should not only provide exposure to different market segments but also to both mature and emerging markets.
Kristof De Graeve
Data & recommendations as of 26 June, 2017 close
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