Barclays Downgrades Auto Sector To 'Negative,' But Reiterates Bull Thesis On Mobileye

In a report published Thursday, Barclays analyst Brian Johnson downgrade the entire U.S. Autos and Auto Parts sector to "Negative" from "Neutral" due to concerns in China, negative sales in the third quarter and declining production in 2016.

"While the sector has underperformed over the past two months, we see potential for this underperformance to continue as China car sales continue to disappoint and as Chinese production turns negative," Johnson wrote. "Frankly, it would have been easier to write a note stating the impact on our estimates is modest, and that the stocks more than discounted the lower estimates. However, we've found it's very difficult to defend our sector on the back of lower sales growth. With the U.S. autos industry having peaked and the European industry recovering very slowly, we see little offset to the slowdown in China."

Johnson said that auto stocks could potentially be "buyable" after the "coming wave of downward earnings revisions" or in the November through January time period when expectations are "reset." The analyst even suggested that auto stocks in its current state is already "one of the cheapest sectors" but the industry needs to go through the bottom of a cycle with minimal bankruptcy risk before investors could become buyers.

Chinese Long-Term Thesis Called In To Question, Hurts GM & Suppliers

Johnson noted that it was "conventional wisdom" that total annual sales in China would reach 30 million units by 2020, accounting for the "bulk of the growth" for auto manufacturers. However, investors are now beginning to question this thesis and perhaps after several quarters of negative growth, the path towards increased auto ownership in China "will be dead."

This is a cause of concern for BorgWarner Inc. (NYSE: BWA) and Delphi Automotive PLC (NYSE: DLPH) as China accounts for a "substantial" percent of the companies backlog.

Johnson also suggested that General Motors Company (NYSE: GM) faces the strongest China headwinds out of all auto companies within his coverage. The analyst reduced his 2016 China equity income estimates by $530 million (7 percent of his prior 2016 net income estimate) while suggesting the company could "easily" see another $500 million of headwinds materialization.

With little in the way of offsets from the rest of the company, General Motors' "cheap valuation" along with its "rich dividend" is essentially "largely irrelevant."

Related Link: Barclays Downgrades GM, Cuts Target To $36

Ford Faces China Risk, But Not As Much

Ford Motor Company (NYSE: F) is "less mature" in China versus General Motors and faces less downside risk in the country. However, Johnson acknowledged the risks are real and a "meaningful" portion of its net income does come from China.

Johnson lowered his 2015 growth estimate by six points to +6 percent and his 2016 growth estimates by seven points to +7 percent. However, the company could outpace the market as it still developing its position in the region and its "broader portfolio" of vehicle lineups makes it better positioned than other foreign car makers in the country.

China Not Crucial For Lear

Johnson stated that Lear Corporation (NYSE: LEA)'s exposure to China is minimal as Chinese headwinds will only "shave" a point off of its organic top-line growth. However, with the North American market "peaked," with little upside from Europe, the analyst concluded that macro is a "net negative" for Lear and its stock will "have a tough time" working in an environment with no upside to earnings estimates.

China Challenges Reinforces Mobileye As ‘Top Pick'

Finally, Johnson argued that in an era of slowing auto growth in China, Mobileye NV (NYSE: MBLY) is an "increasingly attractive" name with little ramifications in the near and mid-term.

Mobileye's exposure to China is "very small" with the majority of the company's upside coming from continued penetration in the North American and European market. The analyst argued that an increased likelihood of regulatory tailwinds makes him "increasingly confident" in Mobileye's ability to thrive.

Summary Of Rating And Price Targets:

• Shares of BorgWarner were downgraded to Equal-Weight from Overweight with a price target lowered to $55 from a previous $70.
• Shares of Ford were maintained with an Equal-Weight rating with an unchanged $16 price target.
• Shares of General Motors were downgraded to Equal-Weight from Overweight with a price target lowered to $36 from a previous $44.
• Shares of Lear were downgraded to Equal-Weight from Overweight with a price target lowered to $107 from a previous $124.
• Shares of Mobileye were maintained with an Overweight rating with a price target raised to $76 from a previous $66.