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The Auto Sector: Finding Value in the Global Supply Chain

March 3, 2017

By Craig Maddock, CFP, FCSI, CIM, FICB, CFA, MBA
Vice President, Investment Management

I have loved cars since I was a boy. Recently, I was in my garage installing new brake pads on my car when I realized that doing some of my own car repairs and becoming an investment manager have kept me in tune with how cars, and the global auto industry, have changed over the years.

Today, President Donald Trump is driving the discussion about the future of the auto industry, something we pay close attention to at MD Financial Management because of our direct investment in the sector and its larger implications for the global economy. But it’s important to remember that although most people think “car companies” when they hear “auto sector,” in reality the sector is so much more. It’s a massive, globally integrated system of suppliers and manufacturers.

It’s a sector that will be hard to just pull apart as part of Trump’s “buy American, hire American” agenda. Car assembly plants have a habit of moving closer to consumers in their end markets so they can save costs. About 8% of the retail cost of vehicle is transporting it to its end market. These direct costs, plus time during shipping, represent tied up working capital. Plants in North America can have cars shipped by rail so that they can be available to the end customer within four or five days, instead of the weeks that it takes for them to come from overseas.

MD has holdings in many global auto sector companies

I definitely think there are more interesting things about this sector’s profitability than the potential impact of the Trump administration. I may love cars, but I also appreciate the potential to unlock great value from the less sexy parts of the industry, like parts manufacturers. MD has holdings in more than 50 companies in the global auto sector across our funds and pools.

Germany’s Continental AG is a great example of one of our holdings. It’s a leading global producer of parts like tires, braking systems, electronics, powertrains and chassis components. Continental posted strong results in 2016: sales increased to around €40.5 billion year-on-year, and they managed to hit a new sales record for tires with more than 150 million sold worldwide.1 MD clients can invest in Continental through MD Equity Fund, MD International Value Fund and MDPIM International Equity Pool.

Magna International is another MD holding I like to talk about. This Canadian company is a leading global automotive parts supplier that also has contracts to build entire cars for BMW and Daimler. It has a global footprint, with 312 manufacturing operations and 98 product development, engineering and sales centres in 29 countries. Magna employs more than 155,000 people.2 MD clients have access to Magna International through six MD funds and three MD pools.

Magna issued its most recent financial outlook on January 11. The company expects continued sales growth and forecasts over US$43 billion in total sales by 2019. The analysts I talk to also say Magna is growing faster than its rivals and that its stock still trades more cheaply, which suggests it could be good value. Magna has also used a lot of its cash flow for share buybacks and it has a decent dividend yield of about 2.3%.

The global growth picture shows changing leadership

Magna projects that the majority of growth in global auto production and vehicle sales will come from China, South America, Eastern Europe and India. These sales projections tell another important story: the sources of industry growth are expected to come from outside North America and many of them have room to grow.

I discussed this with Jessie Magee recently. Magee is a member of the investment team at EARNEST Partners, which advises the MD Equity Fund, MD International Value Fund and MDPIM International Equity Pool. Magee, an engineer by training, knows the car industry from the inside. Before his career with EARNEST Partners, he spent more than seven years in the Research & Advanced Vehicle Technology Division of Ford Motor Company, working on alternative fuel technologies, occupant safety and new product development. 

Magee told me: "There are about 250 million people in China who can afford a car, compared with around 50 million in India. But that’s still a big market and if you think of India being about 10 years behind China, you could argue it offers some long-term growth potential. But today, there are already opportunities to play India from a domestic company perspective. Tata Motors produces everything from small cars to transport trucks and also owns higher-end brands like Jaguar and Land Rover.”

Magee also reminded me that motorcycles are very popular in India and in other emerging economies. These two-wheeled members of the auto sector offer global investment potential—there are more motorcycles sold around the world than cars.

There are other big-picture global facts to consider. China, for example, is the largest car market in the world, and Trump may not want to jeopardize U.S. access. In 2016, GM sold more cars in China than in the United States. And China, despite recent moderating growth, will likely expand its dominance in the sector over the next 10 years.

China is also the largest car market for BMW and Mercedes-Benz, but according to Magee there is an interesting twist to this story. “Buick and Cadillac can charge a price premium over their German rivals because of aggressive marketing that has given these luxury competitors a special American cachet. Buick, for example, sells about five times as many vehicles in China as it does in the United States.”  

The auto sector will remain a key driver of the global economy

At the end of the day, the demand for vehicles will likely continue to move up and down with global economic growth. The Detroit Auto Show is the world’s premier event focused on the auto sector. This year’s show ended on my birthday, January 22. I didn’t get a chance to drive down and see the next-generation models to put on my birthday wish list for 2018, but just as I will always love cars, I know that the global economy will always have a special place for them, too.

Stock Spotlight: Magna International and MD


MD’s Magna Holdings as at January 31, 2017
Fund or Pool Market Value ($) Percentage of Portfolio
MD Balanced Fund 4,731,150 1.07
MD Dividend Growth Fund 3,779,181 1.18
MD Dividend Income Fund 21,405,100 2.28
MD Equity Fund 3,964,525 0.22
MD International Value Fund 389,837 0.47
MD Select Fund 6,644,015 1.39
MDPIM Canadian Equity Pool 23,526,786 0.78
MDPIM Dividend Pool 25,296,222 1.12
MDPIM International Equity Pool 3,455,776 0.24

Source: MD Financial Management

MD’s Auto Sector Holdings

More than 50 auto sector companies are held across MD funds and MD pools.

MD’s Largest Auto Sector Holdings as at January 31, 2017
Security Name Industry Subsector
Adient PLC Auto components
Bayerische Motoren Werke AG (BMW) Automobiles
Boyd Group Income Fund Auto components
Continental AG Auto components
Daimler Ag Registered Shares Automobiles
Denso Corp. Auto components
Honda Motor Co. Ltd. Automobiles
Hyundai Mobis Co. Ltd. Auto components
Kia Motors Corp. Automobiles
Magna International Inc. Auto components

Source: MD Financial Management

The Global Auto Industry at a Glance

Together, auto manufacturers and auto parts makers account for about 20% of the MSCI World Consumer Discretionary Index. Two of the top 10 companies in the sector are auto companies: Toyota and Daimler. This combined industry group is the largest part of the consumer discretionary sector, representing about 2.4% of the investable universe of stocks around the world.

 

Top 10 Constituents of the MSCI World Automobiles Index as at January 31, 2017
Company Country Market Cap (US $ billions) Index Weight (%)
Toyota Motor Japan 156.18 24.93
Daimler Germany 72.16 11.52
General Motors United States 51.16 8.17
Honda Motor Japan 49.05 7.83
Ford Motor United States 45.82 7.31
BMW Germany 34.23 5.46
Volkswagen Germany 34.04 5.43
Tesla Motors United States 32.42 5.18
Fuji Heavy Industries Japan 24.82 3.96
Nissan Motor Japan 24.00 3.83
Total 523.88 83.63

Source: FactSet

1 http://www.continental-corporation.com/www/pressportal_com_en/themes/press_releases/2_corporation/financial_information/pr-2017-01-09-key-figures-en.html

2 http://www.magna.com/about-magna