Will the Auto Sector Hit The Brakes In Upcoming Earnings?

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Is the highly cyclical auto industry finally coming to a peak? U.S. auto sales hit a sales record of just under 17.5 million vehicles in 2015, up 5.7% from the year before, but are expected to decline in 2016. Sales have benefited from widely available access to cheap credit, lower gas prices, a steadily recovering economy, and other macroeconomic factors. Auto manufacturers have also benefited from lower materials costs thanks to depressed commodity prices. Even with record sales, cumulative earnings in the auto industry are expected to decline 25% in Q3 according to FactSet Research.

The U.S. auto industry has been on a strong run for 6 years, but anticipation of a future decline in auto sales has led to poor share performance across most of the auto industry. U.S. auto sales declined in August and analysts have revised earnings estimates downwards for several major auto manufacturers including Ford (F).

Despite a 5% increase in Ford’s second-quarter revenue, net income declined 8.9% from last year as a result of higher incentive and warranty costs. In Q2, the company acknowledged new risks and slowing sales to impact the company’s ability to achieve its full-year guidance. When the company reports on October 27, analysts are expecting $0.22 earnings per share on $32.78 billion in revenue.

General Motors (GM) is looking to repeat a strong Q2 performance when the company reports Q3 earnings on October 19. Second-quarter revenue was up 11%, to $42.4 billion, and net income increased 157%, to $2.9 billion. Analysts estimate earnings per share of $1.44 on $39.11 billion of revenue in Q3. We’ll see if GM can keep up its trend of beating top and bottom-line estimates.

Tesla has struggled with production delays of the Model S and Model X, but the company is expecting to deliver 50,000 Model S and Model X vehicles in the second half of 2016. When Tesla reports on November 2, analysts estimate earnings per share to be anywhere from a loss of $0.46 to a profit of $0.60 on $2.04 billion to $2.64 billion in revenue. As far as operations go, Tesla continues to burn through cash to fuel revenue growth and the company posted a net loss of $486 million in the first half of 2016. Tesla’s planned $2.6 billion acquisition of SolarCity (SCTY) has been drawing criticism over corporate governance concerns and has widely been viewed as a bailout for SolarCity. Tesla CEO Elon Musk is the chairman of SolarCity and owns 21.6% of the company. Future earnings for shareholders could be diluted even further if the company needs to raise additional capital. After raising $1.5 billion in an equity offering in May, the company is considering additional debt and equity offerings to help fund production of the Model 3, its mass-market electric vehicle starting production next year.

Emerging Market Challenges

One of the largest macroeconomic factors impacting auto companies is slowing sales in emerging markets, which not too long ago represented a significant growth opportunity. Sales in Russia and Brazil have been declining and growth in China has slowed sharply in recent years, but started to rebound in recent months. According to the China Association of Automobile Manufacturers, July auto sales were up 26.3% over last year. Future sales growth could slow down as Chinese cities continue to implement new vehicle registration limits in order to combat air pollution. Despite shaky economies in parts of Europe, auto sales in the European Union continue to grow in the high single-digits.

Emerging markets investments tend to be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability.

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