Recall-related headwinds are presently the biggest concerns for the auto industry. The last two years have been brutal in terms of the number of recalls as well as the number of affected vehicles. Just when the road started to feel smooth this year, massive recalls due to the defective Takata airbags steered the sector uncontrollably toward yet another bumpy ride.
Another major issue is the recent slowdown in sales in China. Automakers have been banking on growth prospects in Asia and a downturn in China will have a major impact on global sales. Many automakers have started resorting to price cuts in the country to entice buyers. However, this is bound to have a negative impact on margins.
On the other hand, there are many positives such as exciting vehicle launches, declining fuel prices, impressive domestic sales and a recovery in Europe. Moreover, the sales volume in China is impressive, despite the slowing growth rate in the last few months.
Still, there are plenty of reasons to be careful about the auto industry stock space for both the short and the long terms. Below, we discuss some of the key challenges that investors in the auto sector should watch out for in the coming months and years:
Safety Recalls Weigh on Financials
Safety recalls and related costs have become a major issue for most automakers in recent years. An astounding 632 recalls covering 22 million cars were announced in 2013. In 2014, safety recalls were at record levels.
Automakers recalled over 60.5 million vehicles in the U.S. in 2014, according to the National Highway Traffic Safety Administration (“NHTSA”). This figure is nearly double of the previous record of 30.8 million vehicles in 2004. Moreover, these figures only cover the recalls in the U.S. and the global recall numbers are much higher.
The recall saga continues in 2015. Defective Takata airbags, which resulted in significant recalls last year, can be blamed for the maximum recalls this year. Recently, Takata agreed to acknowledge that 33.8 million of its airbags are defective. This announcement will increase the number of vehicles and trucks recalls due to the faulty airbag issue by nearly 100%.
Takata and 11 automakers, including Toyota Industries Corp (TOKYO:6201), Nissan Motor Co Ltd (OTC:NSANY), Ford Motor (NYSE:F) and Honda Motor Company Ltd (NYSE:HMC) have been affected by the issue. The biggest victim, however, is Honda -- Takata’s largest customer.
The recall-related repair costs intensify the financial burden of auto manufacturers.
Slower Sales Growth, Price Cuts in China
Although China reported exceptionally strong auto sales in 2014, the rate of growth has lately seen a deceleration. By the end of 2014, the growth rate fell 7 percentage points from 2013 end. It declined 6.3 percentage points year over year in the first four months of 2015 as well.
In fact, the sale of commercial vehicles fell 6.5% year over year in 2014 and 19.1% in Jan-Apr 2015. While the sale of passenger cars increased during both periods, the growth rate slowed.
Slowing economic growth in China is leading to the sluggishness in vehicle sales. As China is the largest and fastest growing automobile market in the world, a decline in vehicle sales or even a slowdown in the growth rate can significantly hurt the revenues of automakers.
As a result of the decelerating sales growth rate, many automakers are cutting vehicle prices in China. Automakers usually sell vehicles at double or even triple the price in China from the price set in the U.S. However, they are now cutting prices in the hope of salvaging the situation at the cost of bottom-line growth.
Market Share Concentration
Market share concentration makes the automobile sector highly competitive. The top 10 global automakers account for nearly 81% of the total vehicles sold, according to marketrealist.com.
Although automakers continue to focus on shifting their production facilities to new regions owing to cost and demand factors, developing a supplier network in these unfamiliar regions is one of their greatest challenges, especially when existing suppliers lack the financial strength to expand capacity into new markets.
Moreover, high dependence on automakers makes auto market suppliers vulnerable to pricing pressure and production cuts. Pricing pressure from automakers constricts margins of parts suppliers. Simultaneously, frequent production cuts by automakers to account for market adjustments affect suppliers’ operations.
Some auto industry suppliers that are highly dependent on a few major automakers are Meritor Inc (NYSE:MTOR), Tenneco Inc (NYSE:TEN) and The Goodyear Tire & Rubber Company (NASDAQ:GT).
Bottom Line
This analysis shows that while the industry’s near- to medium-term picture is fairly reassuring, a number of long-term challenges remain.