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Is It Time to Downgrade the Automakers? What You Need to Know

By Rich Smith - Jun 8, 2017 at 11:52AM

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Morgan Stanley's Lear downgrade could be only the beginning.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

It has begun -- the great cyclical downturn of the American auto market.

That seems to be the upshot of a new note out of investment banker Morgan Stanley, which this morning cut its rating on car parts supplier Lear Corporation (LEA 4.31%) from equalweight to underweight. In addition to the downgrade, Morgan Stanley assigned Lear stock a new $134 price target that implies a 12% decline from today's share price of $152 and change.

The downgrade may have implications for the other automotive stocks as well. Here's what you need to know.

Full car lot

Pretty soon, car dealer lots could be jam-packed with unsold cars. That's not a good thing for automotive investors. Image source: Getty Images.

What Morgan Stanley said

Make no mistake: The crux of Morgan Stanley's note this morning was that it no longer thinks Lear is a worthy investment. notes this morning that the analyst thinks this in part because it sees Lear spending more money to develop new products in its e-systems division -- which produces electrical distribution systems such as terminals, connectors, and junction boxes -- hurting Lear's profitability.

According to data from S&P Global Market Intelligence, e-systems produces only 23% of the revenue Lear collects in a year -- but more than 41% of the company's pre-tax profits. Morgan Stanley expects this division's superb 14.1% operating profit margin to contract, however, as development costs begin to bite while Lear faces more competition for market share.

This loss of profitability in e-systems, warns Morgan Stanley, could drive Lear's total profits down by as much as 20% over the next five years.

What Morgan Stanley also said

But that's really more of a micro issue. The macro issue that should worry Lear investors -- and investors in key customers such as Ford (F 2.35%) and General Motors (GM 1.86%) -- is that Morgan Stanley believes 2017 is the year automotive sales in the U.S. finally peak.

Consider: In 2015, consumers in the U.S. bought 17.47 million cars and trucks. In 2016, sales inched up to 17.55 million units. At J.D. Power, this year's sales were forecast to eke out yet another small gain (to 17.6 million units). But after seeing the final tally of sales for April, J.D. Power cut its estimate for this year's car sales to 17.5 million.

This estimate suggests that car sales actually peaked last year. But whether last year or this year, the upshot is that car sales are already at (or at least near) the highest they will go -- perhaps for a long time.

Specifics, please

Here's what Morgan Stanley is forecasting today, laid out nice and clear for you:

  • 2017: Based on the latest data, the seasonally adjusted annual rate (SAAR) of car and light truck sales in the U.S. is trending toward 17.3 million units, 1.4% below 2016 levels.
  • 2018: Next year, that number will fall more than 5% to 16.4 million units.
  • 2019: In 2019, the SAAR will decline a further 8.5% to 15 million units.
  • And in 2020, it will hold steady at 15 million units.

It all adds up to about a 14.5% decline in car sales from last year through 2020.

Final thing: What it means for investors in Ford and General Motors

What's even more disheartening, of course, is that up until today (and against all odds), Morgan Stanley had been predicting that car sales would actually grow to 18.3 million units this year, and keep on growing through 2019 before finally beginning to decline in 2020. In changing its Lear rating today, Morgan Stanley has moved up the date of the car cycle downturn by two full years.

This bodes ill for investors in Ford and General Motors stock -- and investors in Fiat, Nissan, and all the rest as well. Little wonder then that Ford stock is falling 0.4% in morning trading today, and GM stock is down 0.8%. For automotive investors, the headline today seems to be reading:

"Repent, the end is nigh."

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Stocks Mentioned

Lear Corporation Stock Quote
Lear Corporation
$135.63 (4.31%) $5.60
Ford Motor Company Stock Quote
Ford Motor Company
$13.08 (2.35%) $0.30
General Motors Company Stock Quote
General Motors Company
$36.49 (1.86%) $0.67

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