The auto sector is gearing up for a strong performance in the first-quarter 2015 earnings season. The sector is expected to rank second among the 16 Zacks sectors in terms of year-over-year earnings growth and third in terms of margin growth.
The average growth rate of earnings for the sector is estimated at 32.4% for the quarter compared with a negative growth rate of 2.9% expected from all the S&P 500 companies. It is worth noting that the automobile space recorded an impressive 41.8% year-over-year earnings growth in the fourth quarter of 2014 – the highest among the 16 sectors.
Growth Drivers
The expected earnings growth in the first quarter will no doubt be fuelled by strong vehicle sales in key markets. U.S. light-vehicle sales increased for the fifth consecutive year in 2014, improving on the 6-year high achieved in 2013. Sales continue to drive up this year, with a 5.6% year-over-year increase to 3.95 million vehicles in the first quarter. Low fuel costs, an improving employment rate and reduced borrowing costs boosted sales.
Further, sales in China reached an all-time high of 23.5 million last year. It improved 3.9% to 6.15 million units in the first quarter of 2015.
Even sales of passenger cars in the European Union improved 5.7% year over year in 2014 after six years of decline, according to the European Automobile Manufacturer’s Association. The improvement continued in the first quarter with 3.5 million units sold, reflecting an 8.6% rise year over year.
Concerns
Although the earnings of the auto sector are improving significantly, revenues are going downhill. Auto sector revenues fell 1.4% year over year in the fourth quarter of 2014 and are expected to decline 0.5% in the first quarter of 2015.
Moreover, the rate of auto sales growth in China has lately seen a deceleration. By the end of 2014, the growth rate fell 7 percentage points from 2013 end. It decreased 5.3 percentage points in the January-March period as well.
The Way to Pick Right Stocks
Given the strong earnings outlook, it would be a good idea to look at some auto sector stocks when the first-quarter earnings season has just been set in motion.
The large number of participants in the auto industry makes it difficult to shortlist stocks that have the potential to beat earnings. This is where the Zacks proprietary methodology comes in handy. It narrows down the list by selecting stocks that have the combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) – and a positive Earnings ESP.
Earnings ESP shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. It helps in picking stocks that have high chances of posting a positive earnings surprise in their next earnings announcement.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%. Here, we have selected 3 stocks from the automobile sector that have the right combination of elements to report an earnings beat this earnings season.
Allison Transmission Holdings (NYSE:ALSN) has an Earnings ESP of +4.62% and a Zacks Rank #1. The Zacks Consensus Estimate for the company’s first-quarter earnings is 65 cents per share, which reflects an expected year-over-year gain of 17.58%.
Allison Transmission has a history of outperforming earnings estimates. The company delivered positive earnings surprises in the trailing four quarters, with an average beat of an astounding 80.51%.
Indiana-based Allison Transmission is among the major manufacturers of commercial-duty automatic transmissions and hybrid propulsion systems globally. The company also supplies various auto parts and services to customer through 1,400 independent distributor and dealer locations across the world. The company will report first-quarter earnings on Apr 27.
American Axle & Manufacturing (NYSE:AXL) has a Zacks Rank #2 and an Earnings ESP of +3.45%. The Zacks Consensus Estimate for the company’s first-quarter earnings is 58 cents per share currently. The company delivered positive earnings surprises in two of the trailing four quarters, with an average beat of 5.26%.
Michigan-based American Axle is a leading manufacturer and supplier of driveline systems, modules and components for the light vehicle market. The company makes axles, driveshafts and chassis components for light trucks, sport utility vehicles and passenger cars. The company is expected to report first-quarter results on May 1.
Gentherm Inc. (NASDAQ:THRM) has an Earnings ESP of +2.00% and a Zacks Rank #1. The Zacks Consensus Estimate for the company’s first-quarter earnings is at 50 cents per share. The company delivered positive earnings surprises in each of the trailing four quarters, with an average beat of 50.84%.
Michigan-based Gentherm designs, develops and manufactures innovative thermal management technologies. The company will come up with first-quarter earnings on May 7.
Bottom Line
Investing in auto stocks that have an earnings beat potential should yield strong returns in the near term. Earnings above expectations increase investors’ confidence in a stock, and lead to immediate price appreciation.
Moreover, the long-term outlook for the auto sector is positive. This year, auto sector earnings are expected to improve 27.3% over 2014 backed by strong global sales. According to IHS Automotive, global auto sales will improve 2.4% year over year to 88.6 million units in 2015. Other favorable factors like cheap oil and an improving economy will act as catalysts. So investors looking for long-term prospects can take advantage of this buying opportunity.