Credit Suisse Likes Auto Suppliers & Tesla, But Cautious On Ford & General Motors
Dan Galves of Credit Suisse initiated coverage of the auto sector Wednesday.
Galves research into the auto sector resulted in several key findings which actually favor the auto suppliers over the automakers. The analyst speculates that suppliers should see accelerated growth driven by global secular growth trends, modestly recovering volumes and incremental margins in Europe and a continued expansion in China.
Related Link: Credit Suisse Initiates Coverage On General Motors
“We believe that U.S. trend demand is lower than the market things, even a modest rise in rates could have a meaningfully negative impact on U.S. pricing, and regularity costs to meet fuel economy targets are accelerating,” Galves wrote in his note.
U.S. demand levels across the current cycle could be lower than investors think due to weakening Scrappage, Licensed Driver Growth and Miles Driven metrics.
According to Galves, the technical scrappage age of a vehicle has increased by at least 1.3 years since 2006 due to manufacturers selling better quality cars. Meanwhile, Miles Driven per Vehicle has declined by seven percent since 2004 and has fallen every year since 2010.
Driver growth has also declined significantly given the declining rate that young people obtain a license. If current trends of teens and millennials holding off getting a license continue, drivers 60 years or older will make up 30 percent of the population in 2020 versus 20 percent in 2005.
Current U.S. pricing is unsustainable in a normalized rate environment as revenue per car unit is higher by more than $3,000 since 2007; lower rates and longer loan terms have erased any impact on consumer monthly costs.
Galves adds that while rates could stay “unusually low” for a long period of time, a four percent auto loan rate (versus seven percent to eight percent throughout most of the 2000s) should be considered normal across a cycle.
“In our Automaker mid-cycle estimates, we assume a $750 per unit deterioration in price, which corresponds to the impact we expect would occur if Auto Loan rates rose by 100 basis points to 200 basis points,” Galves wrote.
According to economists at Credit Suisse, the Federal Reserve Board is expected to begin increasing benchmark rates in the third quarter 2015.
Increasing content in the Powertrain, Active Safety and Electrical/Electronics segment will support growth for the suppliers well beyond 2020. This translates to cost headwinds for the manufacturers.
Galves states that auto manufacturers will move towards hyper-efficient engines and transmissions due to increasing regulations and consumer demand for higher fuel efficiency.
Powertrain components are projected to grow at an eight percent to 25 percent compounded annual growth rate over the next five years. Active Safety components will grow at a 30 percent compounded annual growth rate through 2020 growing to an $8 billion to $10 billion market (from $1.4 billion today).
“While these trends are a substantial benefit to suppliers, they will result in increased material cost for the automakers,” Galves wrote. “We estimate that automakers will add $700 to $800 per unit of Powertrain costs and $100 to $150 per-unit of Active Safety cost over the next five years.”
China is becoming an increasingly significant part of the supply chain. The analyst identifies several trends that should lead to increased market share for global suppliers, leading to top-line growth above underlying production growth.
Chinese suppliers are expected to represent 17 percent of the global market, double the eight percent global market share Chinese firms held as of 2010.
“For most of our supplier names, China accounts for five percent to 15 percent of current revenues, but 25 percent plus of the total new business backlog, pointing to three-year revenue compounded annual growth rate in the 15 percent to 20 percent range,” Galves argued.
China also holds a cost advantage, as seat belts and airbags can be produced in China for roughly $200 per unit, while North America and European manufacturers produce the same product for $375 per unit.
Platform globalization favor global suppliers, giving the major suppliers pricing power. Additionally, secular trends could fuel M&A activity.
Post-financial crisis much of the M&A activity in the supplier space has flown below the radar, with many private, smaller suppliers contracting. This has resulted in many of the key component groups being controlled by three or four large suppliers.
“Going forward, a desire to consolidate positions in key product groups or with particular customer could drive larger deals,” Galves wrote. “Recent news surrounding confirmed talks between TRW Automotive (NYSE: TRW) and ZF Friedrichshafen (two of the top 15 global suppliers) supports this view.”
Ford: Bright future, but timing uncertain
Several years ago Ford management made the decision to shrink vehicle size and go “full-bore” into downsized, turbocharged engines proved to be exactly what consumers are demanding today. However, a cautious view on U.S. demand and pricing and a belief that North American EBIT will not recover as quickly as the market things forces Galves to stay on the sidelines.
General Motors: Growth negatively impacted by recent events
According to Galves, North American margins are peaking earlier than expected, with further headwinds ahead. The analyst adds that just as the company announced a meaningful dividend, a series of recalls and other issues set the company back $2.5 billion. As such, the likelihood of a meaningful share buyback in the near future is now lower.
Tesla: Not a fair fight
Tesla's Gigafactory could result in a Model S and Model X base battery cost in the $10,000 to $11,000 range while the upcoming Model 3 battery could cost around $7,500. At that point, “Tesla is in the range of cost parity to Internal Combustion vehicles.”
“If Tesla can get to cost-parity with Internal Combustion vehicles and still offer $1,400 to $2,500 per year fuel savings to the consumer, it won't be a fair fight,” Galves claims.
Ratings and price targets
Shares of Ford are Neutral rated with an $18 price target.
Shares of General Motors are Underperform rated with a $33 price target.
Shares of Tesla are Outperform rated with a $325 price target.
Shares of American Axle (NYSE: AXL) are Neutral rated with a $20 price target.
Shares of BorgWarner (NYSE: BWA) are Neutral rated with a $67 price target.
Shares of Delphi are Outperform rated with an $83 price target.
Shares of Lear are Outperform rated with a $114 price target.
Shares of Magna (NYSE: MGA) are Outperform rated with a $128 price target.
Shares of TRW are Neutral rated with a $106 price target.
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