The auto sector offers little shelter from market gyrations, according to Morgan Stanley.
In two reports released in tandem, a team of analysts led by Adam Jonas reviewed a slew of auto manufacturing and dealer stocks, coming to quite a dim view of both. In short, the team argues that inflationary pressures plaguing the market at present are arguably most pronounced in autos. As such, outperformance is not something investors should anticipate.
Downbeat on Dealers
Highlighted as perhaps the most problematic amid recent ongoing market dynamics is the auto dealer space.
Jonas’ team argues that the outperformance of auto dealer stocks like Lithia Motors (NYSE:LAD), AutoNation (NYSE:AN), Group 1 Automotive (GPI), Sonic Automotive (NYSE:SAH), and Asbury Automotive Group (NYSE:ABG) in 2022 cannot continue.
The team noted that the impact of supply constraints have managed to keep gross profit per unit figures across the industry all-time-high. Yet, as consumers weaken, the team assessed this trend as ultimately unsustainable.
“Lack of affordability presents a big ‘tax’ on consumers while dealers have been generating all-time-high GPUs at a multiple of historical levels,” the report read. “We think something has to give.”
The team noted that even aside from the issues in supply chains, rampant inflation, and epidemiological concerns, a tightening Fed is a historical tipping point for auto dealers. Per Morgan Stanley’s research, there is a significant correlation between “big-ticket item” purchases, such as autos, and the movement of the 10-year yield dating back to 2022. Anecdotal evidence from the late 70s into the 1980s is even less encouraging, the report added.
Based on that concise assessment, the bank assigned “Sell” equivalent ratings to 5 auto dealers in their coverage. Both Group 1 Automotive (GPI) and Asbury Automotive Group (ABG) were downgraded in the report itself, with price targets being cut from $187 to $160 and $185 to $162, respectively.
Meanwhile, “Underweight” ratings were reiterated on Lithia Motors (LAD), Sonic Automotive (SAH), and Penske Automotive Group (PAG) with price targets reined in on both Lithia and Sonic. AutoNation (AN) escaped with a “Hold” equivalent rating, though its price target was also trimmed by $1. Only Carmax (KMX) was given an “Overweight” rating, though its price target was cut as well, to $140 from $165.
While the team acknowledged that many dealers have made operational improvements and are not necessarily expensive, per se, the expectation of negative earnings revisions looms over the group.
“We advise investors to wait for negative revisions to allow the names to ‘shrink’ into their multiples,” Jonas’ team concluded.
Mulling Over Auto Manufacturers
The outlook on auto manufacturers was not overly optimistic either.
“It’s extraordinarily challenging to trade auto stocks right now as pent-up demand is being released and forward demand is being destroyed at the same time,” the team wrote.
As a result of this dynamic, the team advised there are “few places to hide” in the sector with target prices in need of paring across the space. In total, the team cut price targets on four separate manufacturers in just the past week.
Fisker Auto (FSR) saw its price target cut to $20 from $30, the team’s target on Rivian Automotive (RIVN) was reined in to $60 from $85, and Aramis Auto saw its target trimmed to just €10 from €24. Still, Jonas maintained “Overweight’ ratings on each of the names even while slashing his expectations for price appreciation.
Pockets of Opportunity
To that end, there was notable enthusiasm for specific auto stocks despite a gloomy view on the auto sector overall.
In particular, the team voiced its preference for “select suppliers” and certain manufacturers aside from the aforementioned names. For example, Ford (F) was upgraded as of late by the team based upon a more balanced risk reward after recent selloffs.
Overall, the team of analysts advised that steep selloffs, led by Tesla (TSLA) as of late, are likely overdone. This overreaction offers an attractive entry point to many stocks populating the auto space, per Jonas.
Adding confidence to the latter group are rosier forecasts for EV sales in China and the potential for more government support to the ailing industry.
“After a faltering start in early May, EV sales edged higher, with major brands gathering pace,” the bank explained. “The market is waiting for more stimulus, but how that affects the growth of [neighborhood electric vehicles] and [internal combustion engine vehicles] will be worth monitoring.”
Based on its own optimistic outlook, the bank views China as an attractive market for autos, breaking with “In-Line” assessments of North America, Europe, Japan, and South Korea. India was also considered an attractive market.
Ferrari N.V. (RACE), Stellantis (STLA), Yongda, NOK Corporation, Mitsubishi Motors (OTCPK:MMTOF), Maruti Suzuki India, Global PMX were cited as top picks across the regions. American Axle (AXL), Aptiv PLC (APTV), and Magna international (MGA) were also assigned bullish upside targets as the bank sees suppliers as the healthiest sub-sector in the auto space.
Read more on recent sale rumors swirling around American Axle.