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Four auto stocks to consider

Lex Hall  |  19 Mar 2019Text size  Decrease  Increase  |  
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Automotive stocks such as General Motors and BMW should generate solid profits and returns for investors albeit at slightly softer levels than last year, according to Morningstar analysis.

Several auto stocks remain cheap – seatmaker Adient, for instance, is trading at a 75 discount – and have sustainable competitive advantages, according to Morningstar’s quarterly Automotive Observer.

That said, macroeconomic threats such as Brexit, international trade tensions and a dip in China demand are set to cloud the market.

Here are four auto stocks to consider, according to Morningstar equity analysts Richard Hilgert, David Whiston and Ivan Su.

BMW opens window of opportunity

The market has discounted BMW on concerns regarding the decline in diesel-equipped passenger vehicles in Europe, a collusion investigation in Germany, international trade conflict, and the potential for increased spending on powertrain electrification and autonomous driving. Our EUR 117 fair value estimate represents a 43 per cent premium to the EUR 82 consensus price target. This stock currently trades at an attractive 38 per cent discount to our fair value estimate.

General Motors on the improve

The investment community has not fully recognized General Motors' potential for margin improvement. We think manufacturing efficiency and economies of scale from consolidating vehicle platforms and increased parts commonization will expand margins. A mix richer in higher-priced vehicles and bold cost-cutting moves in North America and foreign markets also support increased profitability. General Motors' shares are attractively valued, currently trading at an 18 per cent discount to our $47 fair value estimate.

Adient: in the box seat

No 1 automotive seating supplier Adient is a 5-star name in the midst of a turnaround that will take time, and we see no reason it can't eventually have seating EBIT margins in the range of rival seatmaker Lear. When we look at the joint ventures in China and their equity income to Adient, we think Adient has recently traded as if an investor is buying the consolidated seating business for free. Seating is one of our favourite sectors of the auto supplier world. It is an oligopoly, and we expect it to remain that way, because it is hard for an upstart supplier to usurp an incumbent. We think Adient's narrow moat is safe despite the firm's recent troubles. The company holds four moat sources, specifically intangible assets, cost advantage, efficient scale, and switching costs. Adient is extremely cheap, in our view, currently trading at a 75 per cent discount to our $60 fair value estimate.

BorgWarner makes a clean break

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We think BorgWarner is attractively valued, currently trading at a 31 per cent discount to our $56 fair value estimate. Global clean air regulations drive original equipment manufacturers customers' need for higher-efficiency propulsion systems. In our view, the bear case underappreciates BorgWarner's intangible asset and switching cost moat sources. We expect revenue growth will outperform growth in global light-vehicle demand by 2-4 percentage points even when assuming dramatically higher battery electric vehicle adoption. We think investors looking to play the clean air regulation and increasing propulsion efficiency theme in the automotive industry would do well to consider BorgWarner.

Outlook for 2019

Bulls say:

  • Tech innovation in autonomy and electrified powertrains give several auto suppliers an edge in intellectual property
  • Highly integrated long-term contracts and capital intensity fortify suppliers' market share via intangible asset and customer switching cost moat sources
  • Market has ignored the moats of undervalued Adient, BorgWarner, Delphi Technologies, and Tenneco, while some supplier stocks have been valued as though economic cycles no longer exist

Bears say:

  • Global light-vehicle demand to be flat to down by 3pc but a possible no-deal Brexit and international trade conflict represent substantial risks to our forecast
  • US market to soften after posting a modest increase of less than 1pc in 2018. We look for 2019 to decline from 2018 by about 3 to 4pc on a slightly softer economy and modestly tighter credit as policy discipline returns to the subprime market and lower residuals increase new lease payments
  • The European market was hurt by new emissions standards in 2018 and demand should remain flat, barring a no-deal Brexit and an escalation in trade rows
  • Barring state intervention, China demand may dip by 1 to 3pc as softer economic conditions persist and a 10pc consumption tax remains
  • Brazil and Russia will continue a healthy recovery established in 2018
  • Solid demand growth in India continues, with a 4 to 6pc increase



is senior editor for Morningstar Australia

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