The Zacks Domestic Auto industry, despite being highly cyclical, seems to be holding its ground. Rising interest rates and high inflation are not weighing on the demand for vehicles. While the devasted supply chain system is certainly a pain point and is affecting production volumes, increasing the prices of vehicles is largely offsetting the decline in output. Automakers are passing on the escalating costs of commodities to consumers by way of a hike in model prices. Most importantly, the popularity of electric vehicles (EVs) is soaring each passing day and auto biggies are fast cementing their position in this domain. Industry participants like General Motors GM, Ford F and PACCAR PCAR should be on your radar to fetch handsome long-term returns.
The Zacks Domestic Auto industry includes companies that are engaged in designing, manufacturing and retailing vehicles across the globe. These include passenger cars, crossover vehicles, sport utility vehicles, trucks, vans, motorcycles and electric vehicles. The industry — which is highly consumer cyclic and provides employment to a large number of people — is at the forefront of innovation, courtesy of its nature and the transformation that it is going through. The widespread usage of technology and rapid digitization are resulting in the fundamental restructuring of the automotive market. Several companies in the industry have engine and transmission plants and conduct research and development and testing of electric and autonomous vehicles.
Key Investing Themes
Demand Holds Steady Despite Stubborn Inflation: Despite sky-high inflation, rising interest rates and economic slowdown, buyers’ appetite for vehicles has held relatively steady. The top two Detroit auto biggies General Motors and Ford are not seeing signs of softening demand as yet. In fact, in August, new vehicle sales in the United States rose 4.3% year over year and 0.3% from the July level, per Automotive Industry Portal MarkLines.
Supply Chain Snafu Has Been a Major Sticking Point: Automakers are battling a severe chip crisis aggravated by the Russia-Ukraine war and lockdown restrictions in China. Many auto biggies are temporarily suspending operations and slashing their production targets amid logistical challenges. There are no signs of the easing of chip issues in the near term, which are going to limit automakers’ production volumes. Experts expect the shortage to linger in 2023 as well.
Commodity and Operational Cost Headwinds Remain: Prices of raw materials are soaring and are not likely to abate anytime soon. Most automakers have already warned that commodity inflation will remain a major headwind for quite some time. Ford recently announced that its third-quarter profits are likely to take a hit as it expects its cost of auto parts to be $1 billion higher than expected. Additionally, massive R&D expenses for the development of high-tech cars would also likely strain near-term cash flows.
High Vehicle Prices Mostly Offsetting Cost Woes: As inventory challenges are mounting amid supply-demand imbalance, the average prices of vehicles (both new and used) are shooting up. As automakers are successfully managing to pass on the burden of escalating input costs to consumers, their revenues have not dwindled yet. With prices going through the roof, many customers are willing to pay a premium for their preferred vehicle. But then, another set of consumers is unwilling to pay a heavy premium and is waiting on the sidelines in the light of high prices and high borrowing rates.
Soaring EV Sales Continue to be a Bright Spot: Inclination toward green cars is serving as a key catalyst. Climate change concerns, technological advancement and stringent fuel-emission standards are increasing green vehicles’ adoption. Demand for electric cars is off the charts. For the first half of 2022, around 414,000 EVs were delivered. EV share as a percentage of new cars sold improved to 6% in the first half of 2022 from 3% in the corresponding period of last year. The latest Inflation Reduction Act will fuel EV sales further.
Zacks Industry Rank Indicates Decent Prospects
The Zacks Automotive – Domestic industry is a 22-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #95, which places it in the top 38% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates encouraging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. The industry’s earnings estimates for 2022 have risen around 6% since Jun 30.
Before we present you three industry participants worth considering for your portfolio, let’s take a look at the industry’s stock market performance and current valuation.
Industry Outperforms S&P 500 & Sector
The Domestic Auto industry has surpassed the Zacks S&P 500 composite over the past year. The industry has moved up 1.7% versus the S&P 500 and sector’s decline of 14.6% and 14.9%, respectively, over the said time frame.
One-Year Price Performance
Industry’s Current Valuation
Since automotive companies are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 29.34X compared with the S&P 500’s 11.86X and the sector’s 15.82X. Over the past five years, the industry has traded as high as 54.74X, as low as 8.85X and at a median of 15.26X, as the chart below shows.
EV/EBITDA Ratio (Past Five Years)
3 Stocks to Add to Watchlist
PACCAR: A leading name in the trucking business, PACCAR’s wide range of trucks carries a solid reputation. The launch of Peterbilt 579 and Kenworth T680 along with the new line of DAF trucks in the European Union market with higher fuel efficiencies should boost prospects. PACCAR’s accelerated efforts toward electrification, connected vehicle services and advanced driver-assistance system options augur well. Its Parts and Financial Services segments gain from a broad dealer network. PACCAR’s strong balance sheet is complemented by A+ and A1 credit ratings assigned by Standard & Poor’s and Moody’s, respectively.
The Zacks Consensus Estimate for PACCAR’s 2022 earnings and sales implies year-over-year growth of 45.3% and 22%, respectively. The consensus mark for 2022 earnings has moved north by 7.8% over the past 60 days. PACCAR currently carries a Zacks Rank #2 (Buy) and has a VGM Score of B.
Price and Consensus: PCAR
General Motors: One of the world’s largest automakers, General Motors’ U.S. market share was 14.4% of the industry’s total sales in 2021.U.S. legacy automaker General Motors’ prospects shine bright, courtesy of its hot-selling brands in America like Chevrolet Silverado, Equinox and GMC Sierra. GM’s big push toward EVs is commendable. The automaker plans to roll out 30 fresh EV models by 2025-end. Key launches, including the GMC Hummer EV, Cadillac Lyriq crossover EV, Equinox EV, Silverdo EV and Blazer EV, among others, are expected to buoy top-line growth. General Motors has enough cash on the balance sheet to weather short-term headwinds and navigate economic cycles.
The Zacks Consensus Estimate for GM’s 2022 and 2023 sales implies year-over-year growth of 21.5% and 6.5%, respectively. Over the trailing four quarters, the company surpassed earnings estimates thrice and missed once, the average surprise being 18.9%. General Motors currently carries a Zacks Rank #3 (Hold) and has a VGM Score of A.
Price and Consensus: GM
Ford: The U.S. auto giant’s prospects are getting bolstered by a strong vehicle mix, supported by F-series trucks, Maverick pickup and SUV models, including Escape, Explorer, Expedition, EcoSport and Edge, which is impressive. With Mustang Mach-E, E-Transit and F-150 Lightning, the robust BEV lineup would further aid deliveries. The Ford+ plan, with a deep focus on increasing profitability, exploring the e-mobility future and enhancing customer experience, sparks optimism. Ford’s ambitious rejig plan to split its EV business into a separate unit within the company will unlock growth opportunities. The company’s improving financials provide a solid foundation for investment in Ford+ priorities.
The Zacks Consensus Estimate for Ford’s 2022 earnings and sales implies year-over-year growth of 32% and 16%, respectively. The consensus mark for 2022 earnings has moved 10.6% north over the past 60 days. Ford currently carries a Zacks Rank #3 and has a VGM Score of B.
Price and Consensus: F
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