While storm clouds have been gathering over the US sector for months, with various adverse news reports building in recent weeks, such as the recent spike in subprime auto loans, which jumped 27% in August, or near record new-car sales incentives, or even Ford’s recent warning that sales have “reached a plateau” and will be “at a lower level” in 2017, the straw that may have broken the camel’s back was unveiled today by Goldman which in an extensive, 92-page report slamming the US auto space, said that “the next leg is down” adding that “the US Auto cycle peaked in 2015 and is currently being held at a plateaued level by increasing OEM incentives” and predicting that “this environment can hold through 2017, but we see a path to normalized US SAAR (15mn) beginning in 2018.” Oh, and for good measure it also downgraded new tech auto darling Tesla from Buy to Neutral with a $185 price target.
Here are the big picture details from Goldman’s David Tamberrino:
We lower our Autos and Auto Parts coverage view to Cautious from Neutral. As we progress through the later stages of the US auto cycle, we expect a sales plateau through 2017 held up by increasing OEM incentives. Beyond this, we see US light vehicle sales mean reverting back toward normalized SAAR of 15mn from 2018 through 2020 as pent-up demand clears through. In addition, as we dissect some of the drivers of the later stage growth, we expect the non-recurrence of several tailwinds (higher leasing penetration, higher non- and sub- prime FICO score penetration) in addition to macroeconomic factors (rising interest rates and crude oil prices) to be headwinds to further growth and the favorable pricing environment for both OEMs and suppliers.
With historical precedents for auto stock valuations to compress to trough multiples on peak earnings, we see room for further multiple compression despite an unsynchronized global production environment. Furthermore, with the recent global downturn still very fresh in investor’s minds, we believe there is a greater probability that auto stocks also go to trough multiples on trough earnings. In this scenario, OEMs would underperform the rest of our coverage – even contemplating total shareholder returns given current mid-single digit dividend yields.
Against this backdrop we do still see room for auto suppliers with geographic balance and exposure to secular content growth opportunities to be outperformers. We remain constructive on shares of DLPH, HAR, and GT where we maintain our Buy ratings. However, we do see downside potential for shares of LEA, which has a more commoditized product and elevated expectations. Among our covered Detroit-based OEMs, we see pressure to results for both Ford and GM, but see a relatively higher expectation set for GM compared to Ford which has appropriately set expectation levels low in the late stages of the US auto cycle.
OEMs: Pressure from both earnings declines and trough valuation multiples likely to offset dividend yield longer-term
- We recognize that the dividend yields for both Ford and GM (currently at 5% each) are likely to provide a buffer against significant downside pressure to the shares over the next 12-months. Nevertheless, our 12-month price targets of $12 and $29 for Ford and GM imply downside to the shares of 2% and 10%, leading to a slight decline in total return for these stocks.
- We believe the pressure on these stocks is going to come from a lack of earnings growth as North America earnings are peaking this year (excl. 1x items in the case of Ford), combined with a historical tendency for these stocks to trade at a trough multiple on peak earnings.
- Of course we recognize that considerations going into valuation will tie around the repair of the balance sheet and long-term liabilities that have occurred since past cycles as well as the potential implications that ride-sharing and autonomous vehicles may present to this industry.
- Between the two, we favor Ford (Neutral) over GM (Neutral) as we believe a low expectation level has been appropriately set for the former, whereas the latter will be coming off a strong year in 2016 with incremental regulatory content driven additions ahead of it on its upcoming truck refresh and Chevy Bolt launch. Furthermore, as the industry continues to adjust to a changing business model towards mobility as a service, we see room for OEMs to collectively overspend/acquire, weighing on results and eating into potential shareholder returns.
- That said, we expect GM’s near-term results to be strong (we are 8% above the Street for 3Q16) and without an anticipated dividend cut, we believe the current spread against the 10-year is enough to keep yield focused investors interested in the company’s shares.
Suppliers can still see EBITDA growth from content per vehicle and Europe/China production
- Suppliers, on the other hand, would still be positioned for share price appreciation – even at trough multiples, as international growth continues in Europe as well as in China and as secular growth drivers increase content per vehicle.
- Within the group we favor DLPH (Buy) given its mix of active safety, infotainment, electrical architecture, and powertrain segments that can drive growth 600bps above the addressable market and Harman (Buy) where we see secular-driven topline revenue growth 600bps above auto production, in addition to a sustainable competitive advantage relative to peers with its recent software/security acquisitions.
- We also see upside to shares of GT (Buy) where secular growth in high-value add tires and 80% EBIT exposure to the replacement business act as a buffer to declining US light vehicle production.
Dealer valuations at trough and we do not see earnings declining until 2018
- We raise our coverage view for Dealers (AutoNation and Group 1) from Cautious to Neutral despite headwinds we see in US SAAR given the more defensible Parts & Service business, and as the group is trading at historical trough multiples.
- Defensive P&S business: With the 0-5 year old vehicle population continuing to grow over the coming years as a result of the last few years of SAAR strength, there is a natural tailwind to Parts & Service – which typically represents over 40% of dealer gross profit.
- Furthermore, we believe Dealers have the opportunity to be more acquisitive through the downturn driving topline and bottom line growth through inorganic opportunities.
As for Tesla…
We downgrade shares of TSLA from Buy to Neutral and lower our 6-month price target to $185. TSLA shares were up only 0.1% vs. the S&P 500 +5.0% and our coverage +6.0% since being added to the Buy list on May 18, 2016, as management’s deployment of capital for potential M&A has likely weighed on investor sentiment on the concept stock. We now see incremental risk to the business related to management’s willingness to deploy capital for M&A, and we believe that any delay in the company’s timeline to launch its new Model 3 will be detrimental to shares. We also note that our illustrative pro-forma analysis for the proposed combination of TSLA and SCTY implies increased corporate leverage and exacerbated cash burn – though we take no view on the likelihood of the deal closing. However, with solid 3Q16 deliveries, above Street consensus estimates for 3Q16, and potential downward catalyst of a missed Model 3 launch timeline out in 2H17, we prefer to be Neutral on shares in the near-term.
We value the company in two parts – its Automotive segment and its nascent Tesla Energy business (Exhibits 40 and 41). For the Automotive business, we model our base case, a downside case, and three “disruptive” upside cases based on the potential upside to the EV market – similar to historical precedents. We then run P/E valuations off the five separate P&Ls, taking the average stock valuation from years 2019 through 2025 and discounting back to present at a 25% discount rate (up from 20% given incremental risk related to management’s willingness to deploy capital for M&A). For Tesla Energy we value the potential ramp of the business through 2020E based on our forecast for the company’s Gigafactory output. For more detail on our disruptive scenarios and price target methodology, see our March 18, 2014 report, Quantifying Disruption – TSLA’s impact on Auto and grid storage seems to be discounted.
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