Auto Demand Hits a Pothole
The damage won't be fixed overnight, but we don't believe it's structural.
Global light-vehicle demand has hit a deep coronavirus pothole. While the extensive damage requires a lengthy repair--we don’t expect global demand to reach more normal levels until 2023--we do not believe the damage is structural. Before the pandemic, we forecast 2020 world light-vehicle demand to be up 1% to down 2%. We now expect 2020 world light-vehicle demand to drop between 17% and 23% as we consider the industrywide closures of dealerships and automobile factories in response to the coronavirus pandemic.
There are risks to our new forecast: There could be another COVID-19 worldwide wave. Our optimistic China forecast for a solid recovery in the second half of 2020 might not materialize. The duration and severity of the U.S. recession could be worse than we expect. Or second-half 2020 demand in Europe might be further adversely affected by Britain’s exit from the European Union (a ratified trade deal is due Dec. 31) and U.S. trade conflict.
Uncertainty continues to wreak havoc on auto sector stock prices and cause market volatility. But for patient, long-term investors, we view the coronavirus crisis as an opportunity to own select auto stocks at significantly discounted prices. Even though our top picks are up significantly from their March 2020 lows, we think BMW (BMW)/(BMWYY) and General Motors (GM), as well as BorgWarner (BWA), have substantial upside.
Our Key Takeaways
BMW stock is up 62% from a low of EUR 37.66 on March 19. Still, its market valuation represents a 49% discount to our EUR 120 fair value estimate. In addition to COVID-19 uncertainty, we believe concerns about transient higher spending levels to launch vehicle electrification as well as lower contribution margins from electrified vehicles has caused the market to overlook the company’s narrow economic moat, derived from an intangible asset moat source, including brand strength and intellectual property. Our narrow moat rating is evidenced by BMW’s return on invested capital, which has averaged 7.8 percentage points in excess of weighted average cost of capital, or economic profit, since 2002.
GM shares have risen 87% from a low of $14.33 on March 18. Even so, GM’s current stock price is at a 44% discount to our $48 fair value estimate. Besides the uncertainty arising from the coronavirus, we think the market has unfairly discounted GM because of incredulity toward the manufacturing efficiency of postbankruptcy (2009) New GM versus prebankruptcy Old GM, exemplified by a dramatically reduced unit volume break-even point, as well as consumers’ perception gap between competitors’ and GM’s product quality.
Since March 18, BorgWarner shares have rebounded 96% from a low of $19.73. However, the stock currently trades at a 35% discount to our $60 fair value estimate. In our opinion, because BorgWarner (as well as acquisition target Delphi (DLPH), due to close in the second half of 2020) has a substantial product portfolio in engine parts, concerns about the demise of the internal combustion engine have caused the market to overly discount the company’s growth potential from vehicle electrification, in addition to COVID-19 uncertainty. We also believe that concern about potential internal combustion engine obsolescence has caused the market to overlook BorgWarner’s narrow moat derived from intangible assets (intellectual property) and switching costs, evidenced by an average annual 5.6 percentage points of economic profit since 2002.
Barring another COVID-19 wave that shuts down global vehicle production and closes dealerships worldwide for a second time, we expect 2020 global light-vehicle demand to be down 17%-23% versus our original forecast of up 1% to down 2%. We set a wider-than-normal band around our updated demand forecast to reflect greater uncertainty from the coronavirus impact.
We had originally forecast a 4%-6% increase in 2020 China light-vehicle demand, but our updated forecast is a 2%-8% decrease. We expect government stimulus in various forms, coupled with a gradual release of pent-up demand, to result in year-over-year sales growth for Chinese automakers in the second half of 2020.
In the United States, light-vehicle demand started the year comfortably above our 3% decline forecast made in January, with sales in the first two months of the year up 4.5%. We now forecast a 14%-20% decline to around 14 million units. The U.S. designated new-car dealers as essential on April 17, which allowed many stores to reopen, depending on state and local officials. As a result, sales from March to May were not as negatively affected as harder-hit sales in other markets like Europe, India, and Brazil.
We forecast a 29%-35% drop in 2020 Europe light-vehicle demand versus our prior forecast for flat to down 2%. Most of Europe’s new-car dealers were on lockdown for a month to a month and a half longer than those in the U.S. Also, light-vehicle demand in the region is clouded not only by COVID-19 but also because of automakers’ need to push many new electrified vehicles to meet more-stringent European Union emissions rules, Brexit trade negotiations, and U.S. trade tensions.
We forecast 2020 Japan light-vehicle demand to decline 15%-21%, compared with our previous estimate of a 5%-7% decline. Demand was already waning before the pandemic because of a higher consumption tax. Access to sales points were less restrictive compared with some countries, even though the government declared a state of emergency on April 7, which was lifted on May 25.
We had originally believed that 2020 India light-vehicle demand would see a nascent recovery, expecting a flat to up 2% market, from an economic recession-hit 2019 demand level, which saw a 12% year-over-year drop. However, the COVID-19 lockdown was stricter in India, which was the only major market we forecast that had zero new passenger vehicle sales for April. We now forecast light-vehicle demand in India to be down 28%-34%.
Before the pandemic, Brazil had been on track to continue the recovery that began in 2017, as labor and pension reforms gained traction in the economy. Our original forecast was for an 8%-10% increase in 2020, but after COVID-19, we now forecast a 26%-32% drop in light-vehicle demand. While President Jair Bolsonaro has opposed lockdowns, state governors began issuing stay-at-home orders on March 17. As a result, light-vehicle registrations declined 22% in March, 77% in April, and 76% in May.
We forecast 2020 Russia light-vehicle demand to decline 23%-29% versus our original forecast for a 1%-3% increase. At the beginning of 2019, Russia raised its value-added tax to 20% from 18%, damping light-vehicle demand by 2.3% last year. While demand was on track with our forecast through March this year, light-vehicle registrations dropped 73% in April and 52% in May as the country initiated a nationwide lockdown on March 28.
Richard Hilgert does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.