Auto Industry Stock Outlook - September 2016

Will the Second Half Disappoint?

The auto sector has been performing exceptionally well this year, despite concerns over plateauing sales in the U.S. The sector’s earnings outperformed nearly all of the other Zacks sectors in the first two quarters.

Strong auto sales in key U.S., China and Europe markets are boosting the performance of automakers. Their margins are also benefiting from an increase in sales of higher margin vehicle segments, such as SUVs and light trucks, due to low fuel prices.

However, expenses related to safety recalls and negative currency effects are some headwinds. Massive recalls related to Volkswagen (DE:VOWG_p) AG’s (VLKAY) emission scandal, General Motors Co (NYSE:GM).’s (GM) ignition switch defect and Takata Corp’s defective airbag inflators have been hurting the auto sector.

Despite the emission scandal, Volkswagen managed to become the highest selling automaker in the first half of the year. With sales of5.12 million units, it edged past Toyota Motor Corp. (TM) that sold 4.99 million vehicles globally. Toyota reigned as the leading automaker for four years in a row since 2012. With sales of 4.76 million vehicles, General Motors came in third.

While the auto sector has had a good run so far, projections for the latter half of the year are not promising. In fact, estimates for the third quarter have fallen significantly since the beginning of July.

Zacks Industry Rank – Mixed Outlook

The distinctive attributes of the auto industry prompted us to have a dedicated sector for the industry in our database. The automobile sector is one of the 16 Zacks sectors, unlike the S&P classification, wherein autos are part of the Consumer Discretionary sector. The S&P has 10 sectors compared to the 16 sectors for Zacks.

At the expanded classification level, the Zacks auto sector is divided into five industries: Auto-Domestic, Auto-Foreign, Auto/Truck-Original, Auto/Truck-Replacement and Engines. The sector’s retail operations are part of the Zacks Retail sector in two industries: Auto/Trucks and Other Auto Parts. The level of sensitivity and exposure to the different stages of the economic cycle vary for each industry.

The current Zacks Industry Rank is #186 for Auto-Domestic, #66 for Auto-Foreign, #46 for Auto/Truck-Original, #4 for Auto/Truck-Replacement, #112 for Engines, #56 for Retail/Wholesale Auto/Truck and #190 for Retail/Wholesale-Auto Parts. As a reference point, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,’ between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.’

This implies that the outlook for auto-related industries is mixed. We rank all 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each.

Sector Level Earnings Trend

The auto sector is expected to contribute 2.3% to the total S&P 500 earnings in 2016. This is more than double its 1% market cap weight in the index at present.

Looking at the overall results of the auto sector, earnings surged 56.5% and 16.2% in the first and second quarters of 2016, respectively. Auto sector earnings are expected to fall 17.6% in the third quarter and 15.2% in the fourth quarter, placing the sector among the laggards.

Total revenue increased 5.1% year over year in the first quarter of 2016 and 5.8% in the second quarter. However, revenues are expected to move down 5.9% in the third quarter and 2% in the fourth quarter.

Despite the weak outlook for the upcoming quarters, earnings for 2016 are expected to rise 1.8% over 2015. However, revenues for the year are expected to go down 0.9%.

For more information on earnings for this sector and others, please read our latest 'Earnings Trends' report.

Bottom Line

The auto sector is currently facing several opportunities as well as challenges. While low fuel prices, attractive financing options and impressive vehicle launches are driving vehicle sales, headwinds include slowing sales growth in the U.S., the negative impact of currency translation and high levels of safety recalls.

Nevertheless, the outlook for global vehicle sales for 2016 remains strong with the projection of a 2.7% rise to nearly 89.8 million vehicles by IHS Automotive. At this juncture, we recommend stocks such as Superior Industries International, Inc. (SUP), Tata Motors Limited (TTM), Tenneco Inc. (TEN) and Standard Motor Products, Inc. (SMP), which sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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