Morningstar - Q2 2023 - 66

Investors
Taking the Long Road
There are speed bumps ahead, but the
automotive sector has promise.
SECTOR RAP
Laura Lallos
In their March Automotive Observer,1
Morningstar
analysts Rich Hilgert and David Whiston
address the obstacles facing the automotive
industry today. Chip shortages are at the
top of list, along with an array of worrisome
possibilities: intensifying inflation, rising interest
rates, recession in major markets, escalation
of the war in Ukraine, and a resurgence of
COVID-19. What's more, as Kristoffer Inton details
in a recent ESG Industry Landscape Report,
there are material environmental, social,
and governance risks that these companies
must manage-most notably carbon and
product governance.
But Morningstar's analysts incorporate such
risks into the Morningstar fair values of these
companies' stocks. A long-term investor
who is comfortable with the variables at play
can find some attractive valuations today.
I spoke with Hilgert, Inton, and Whiston to learn
more about the issues and opportunities
at hand. Our discussion reflects conditions and
valuations as of March 7 and has been
edited for length and clarity.
Laura Lallos: Dave and Rich, I last interviewed
you in the midst of the 2020 coronavirus
crash, when factories were closed. You had concerns
about restarting production in a just-in-timedelivery
industry. Three years later, we are still
seeing the fallout.
David Whiston: The magnitude of it is pretty
devastating. Before the pandemic, we had
light-vehicle inventory in the U.S. approaching
4 million units. By September 2021, we
bottomed out at under a million units. More lately,
the chip shortage has improved. The light-vehicle
inventory has gone up month over month
now for seven straight months, though we're only
back to 1.7 million. General Motors GM and
Ford F have insisted they're not going back to past
inventory levels, because they want to preserve
pricing power.
However, since late 2021, other things have
happened. Interest rates started to increase. Then
we had the invasion of Ukraine. There's a
lot of uncertainty now. Many people are convinced
we will have a recession. I feel that autos
already had its recession-2022 was the worst
year for sales since 2011.
Richard Hilgert is a senior equity
analyst at Morningstar Research
Services LLC.
David Whiston, CFA, CPA, CFE, is
a sector strategist at Morningstar
Research Services LLC.
softness is a big risk not only in the United States
but in all the major global automotive markets.
Rising interest rates and increasing inflation have
taken money out of consumers' budgets.
This gives me some concern about where
we could be in terms of total production for the
full year. But by 2024, we should have
even better inventory and availability. This is
going to be a steady progression higher
as the chip shortage alleviates over time. By 2025,
we have a better chance at getting back
to more normal sales volume, production volume,
and inventory levels.
Lallos: Kris, what about the material ESG risks that
the industry faces-what are the bigger issues there?
Kristoffer Inton is an equity
strategist, ESG, at Morningstar
Research Services LLC.
Inton: The industry faces many ESG risks, but
for the most part, they appear to be manageable.
The most obvious material ESG risk is carbon.
Autos are one of the biggest overall contributors to
greenhouse gas emissions globally, and we expect
stricter regulation around those emissions and
significant reductions over the next 10 years or so.
It's unlikely that auto companies will hit emissions
targets solely by improving fuel efficiency from
internal combustion engines. As a result, the auto
team forecasts significant growth in both
battery-electric vehicles and hybrids through 2030.
They think that two thirds of cars sold by the
end of the decade will be of those two kinds. If
the cars you're making are battery-electric or
hybrid, the risk that comes from your products and
services emitting carbon is obviously going
to come down a bit.
Richard Hilgert: There's also been port congestion
around the world, creating logistics disruption.
COVID-19 in China has had factories either
completely shut down or slowed down. Economic
The other major ESG risk is product governance,
which is largely about safety. Auto travel is the
riskiest form of all travel. Many times, it's the fault
of the user. What companies would like to do is
1 Hilgert, R., Whiston D, & Sun, V. 2023. " Moats, Motors, and Markets 2023: Global Autos Moat Overview, Actionable Ideas, and Forecast. " Morningstar Automotive Observer. March.
2 Inton, K. & Gams, A. 2023. " Auto OEMs and Suppliers: Despite a Traffic Jam of ESG Risks, Firms Can Navigate Through. " Morningstar ESG Industry Landscape Report. Feb. 28.
66
Morningstar Q2 2023

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