The author is an analyst of Shinhan Investment Corp. He can be reached at email@example.com. -- Ed.
1-1) Downward revision of demand outlook
1Q20, Korea and China saw auto sales decline by 7% and 43% YoY, respectively, due to disruptions in supply chains caused by the COVID-19 outbreak. With the novel coronavirus spreading to Western countries from March, we expect demand shock in the US and Europe going forward. Auto sales in 2Q20 should plummet by 45% YoY in the US and 49% YoY in Europe. Global auto demand, while affected by uncertainties, is projected to fall by 27% YoY in 1H20 and rebound slightly by 2% YoY in 2H20.
1-2) Earnings reduction in 1H inevitable but bearable
Automakers saw their auto sales slow in 1Q due to plant shutdowns in Korea and China. However, gains from a weak Korean won should have helped offset sluggish sales, limiting the drop in combined operating profit to 8% YoY. Auto parts makers are likely to report mixed results, depending on their sales exposure to China (combined operating profit -12% YoY). Tire companies are expected to have recorded a 28% YoY decline in combined operating profit due to the prolonged market slump.
Despite market concerns over weak earnings, we note that domestic auto companies are not facing a liquidity crisis. Ford Motor, the second largest automaker in the US, has suffered a series of credit rating downgrades. Its debt is now rated as junk. We focus on the difference in production/sales portfolio between Ford and domestic automakers. Ford has concentrated its resources in the North American region, which accounts for 53% of production and 70% of sales. In comparison, Hyundai Motor and Kia Motors have a low dependency on domestic production (Hyundai 39%, Kia 53%) and resolved production issues at domestic plants.
1-3) Domestic automakers to outperform global peers upon market recovery
Domestic automakers are facing more favorable demand and supply conditions vs. global peers, and thus better positioned to capitalize on a recovery from the COVID-19 crisis. First, we expect relatively solid auto demand in Korea thanks to new car launches. The YoY drop in demand this year should be limited at 2%, vs. 14% in the US, 20% in Europe, and 11% in China. Second, production is recovering at plants in Korea and China, major production bases for domestic automakers. This stands in contrast to the US and Europe suffering from a supply shock.
The auto sector has been among the worst performers across major stock markets over the past month, with correction sparked by liquidity concerns. Domestic automakers are expected to outperform global peers once auto demand begins to recover, given that they have already suffered and overcome a supply shock and should see recovery in productivity ahead of peers. Our top picks are Hyundai Mobis, Mando, and Hyundai Motor, which stand to benefit from earlier recovery of Korea/China value chains vs. other regions.