Even if you love a big SUV, we're rather 'compact' on auto stocks

June 26, 2019 Mark Fairbairn

           

Whether you're passionate about your wheels, or just Uber from Point A to Point B, there may be a few sharp corners ahead when it comes to investing in cars and the auto industry.

Talks for a merger between Fiat Chrysler Automobiles and Renault suddenly hit the brakes last week, although both sides left room for future negotiation in their proposal to bring together 15 brands, from Alfa Romeo to Maserati, to the low-cost Dacia and Russian Lada.

After all, shareholders had previously been told a combined company would benefit from “the scale, expertise and resources to navigate the rapidly changing automotive industry," according to a Fiat statement.

What I see is another sign of an industry on the defense.

An expensive ride with limited returns

In context of a bigger trend, we have limited exposure to the automobile industry, generally, and are underweight across all our international MD funds and MDPIM pools, relative to their MSCI EAFE benchmarks.

Global car sales have been flat since 2016, amid the emergence of electric vehicles, self-driving cars, car-sharing services and changing tastes and attitudes about mobility.

Shifts in demographics and customer preferences have led to slowing demand in developed markets, leaving most growth focused in Asia's emerging markets.

Many industry watchers are talking about signs of "peak car." After all, does it really make sense to spend $30,000 or more to own something that is parked 90% of the time, plus the cost of insurance, fuel and maintenance?

Among traditional automakers, we see an industry with little to no growth, very high capital requirements, manufacturing plants that are expensive to re-tool, and high labour costs.

That adds up to: not so attractive. It's why we tend to not invest much in the way of car companies directly, seeing more potential to unlock value from other parts of the industry.

Kicking tires in our portfolio

Even if industry's big wheels consolidate, the results are likely to be quite tangential to our portfolios. For instance, we don't own FCA (Fiat Chrysler) at all. We do hold Renault in our international funds as part of the value mandate managed by our sub-advisor, LSV Asset Management. It specializes in finding out-of-favour (undervalued) stocks in the marketplace that have potential for near-term appreciation.

Where we do own automotive stocks in our portfolios, there also tends to be an Asian tie, in markets where car ownership is rising and is still seen as a status symbol. That's either directly, through Chinese companies like SAIC Motor Corporation Limited (held in MDPIM Emerging Markets Pool) and BYD (held in the MDPIM International Equity Pool), or indirectly through companies that have benefited from growth in the region, such as Daimler or Isuzu.

We own Honda in the MDPIM International Equity Pool, however that is as much for the strength of its fast growing, high margin motorcycle business across emerging markets, as for its auto business.

The future of cars may be... something else entirely

Auto makers recognize China's enormous potential as a market. Yet it's worth noting that the Chinese government is now trying to balance growth of an important industry—that makes more cars than any other country—against environmental and traffic concerns.

In recent years, major cities in China have restricted the number of licenses for new vehicles in a bid to unclog their infamous traffic jams. This has weighed on cars sales.

You can see the results of these policies on the streets: Electric cars, including fleets run by ride-sharing services, are a common sight in many parts of China. The country also operates more than 99% of the world's electric buses.

I enjoy test-driving a nice car as much as anyone, but know that luxury brands don't always make the best investments—whether parked in your driveway or in your portfolio.

 

About the Author

Mark Fairbairn

Mark Fairbairn, CFA, B.Eng., is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.

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