2 Auto Picks Among Modest Expectations

Dave Whiston: Our global automotive team expects 2020 global light vehicle sales to be in a range of a 1% decline to a 2% rise over 2019. Our forecast may be revised downward if the coronavirus situation meaningfully hurts demand for a large portion of the year. We expect growth in China, Brazil, and Russia, low single-digit declines in the U.S. and EU, and a mid-single-digit decline for Japan as that country pays the price for raising its consumption tax last October to 10% from 8%.

For the U.S., we forecast about a 3% drop in 2020 light vehicle sales to a range between 16.5 and 16.7 million units. This year started off with sales down only 0.2% year over year in January. Car models remain out of favor, falling 10.3% in 2019, while light truck models, which are crossovers, SUVs, vans, and pickup trucks, grew 2.8% last year. For the full year 2019, light trucks increased their sales mix by 290 basis points to 72%, with the Detroit Three’s mix higher in the mid-80s to low 90s. We see continued penetration at the expense of car models because there's still many people out there driving a car nearly 12 years old on average, and we think those owners will want a light truck when they eventually have to buy another vehicle. Another reason we expect more light truck penetration is the Detroit Three have nearly exited cars altogether, with a few exceptions, such as the Chevy Malibu midsize sedan. We believe fewer car options should lead to more light truck growth over time and a buyer doesn't have to sacrifice a lot of fuel economy anymore to buy a bigger vehicle.

However, even light truck growth slowed in 2019 with the 290-basis-point increase less than the 470-basis-point increase for 2018 over 2017. Furthermore, the SUV segment’s share of 8.4% actually fell by 20 basis points last year and crossovers’ 210-basis-point gain was less than the 380-basis-point gain they had in 2018. Pickups should remain strong at about 18% share, and this year has a full year of GM’s new truck plus the new generation Ford F-150.

Employment is a huge driver of auto sales in the U.S. and it remains healthy. In past cycles auto sales have declined at least several months before the number of Americans unemployed increased. The first part of that trend is playing out again as trailing 12-month sales each month for 2018 and 19 have declined for 18 of 24 possible months. Through January 2020, the number of unemployed has declined year over year every month since June 2010, except for a 0.5% rise in September 2016. This suggests to us sales won’t collapse in 2020, but we also don’t think the number of people unemployed can go down forever.

Credit remains reasonably healthy and New York Fed data shows originations to subprime borrowers as not out of control; however, delinquencies over 90 days are rising. Despite a reasonably healthy lending environment, automakers are pulling back on leasing. With off-lease vehicles per Cox Automotive expected to remain near peak levels of last year in the low 4 million unit range, versus just 1.5 million back in 2012, we expect a move into used vehicles this year preventing new vehicle sales growth in 2020. OEMs are wisely expecting some consumers to go back to buying used over new vehicles as used supply finally gets back to a more reasonable level following the massive plunge in used supply when new vehicles cratered during the Great Recession. More used vehicle supply means lower residual values for vehicles being leased now, which means OEMs will likely keep pulling back on leasing. In 2019, Experian data shows leasing as a percent of all new vehicle sales down in each of the first three quarters of the year, with fourth quarter yet to be released. We don't think it's time to panic about U.S. auto demand, but we think the party is getting late and Trump's trade policies around European imports are still a wild card for this year.

Best Ideas in U.S. autos are GM and Adient, the largest seating supplier in the world. GM’s turnaround and buybacks got delayed due to the 40-day UAW strike last fall, but 2020 guidance is for a solid free cash flow year, and we like that buybacks are resuming at probably at least $2 billion worth. Adient is not a name for everyone, in our opinion, because its turnaround from many operational issues will take years, but we think its fiscal 2019 was the worst of the bad news. On Jan. 31 Adient announced noncore asset sales to raise about $400 million of cash to pay down its large debt load and posted a large earnings beat that caused the stock to rise over 30% that day. We see more large upward volatile moves like that possible as Adient shows the fruits of its restructurings, and debt paydowns give shareholders a bigger piece of the firm’s enterprise value. Adient to us is so undervalued that reasonable after-tax earnings multiples of its Chinese equity method investments’ earnings means that the market is valuing the consolidated seating business, a nearly $16 billion revenue business, at negative values or barely positive ones, a severe mispricing in our view that means you can get the largest seating business in the world for practically free.