Automotive Sector Watch: Recalls, Legal Charges, And Increasing EV Competition Suggest Heightened Risk

By David Fisher
FCA Emissions, VW Legal

Disclosure: The author of this report has a long position in Fiat Chrysler Automobiles NV (NYSE:FCAU; IM: FCA) and General Motors Company (NYSE:GM). Positions can change at any time without notice.
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Event Risk In Plain View

This week brought more gloomy news to the automotive sector: Fiat Chrysler Automobiles NV ( NYSE:FCAU) was forced to recall more than 800,000 vehicles to replace failing catalytic converters, and Volkswagen AG (ETR: VOW3) was charged by the U.S. Securities and Exchange Commission with defrauding investors over bonds that it sold in the past.

These events underscore the risk automotive manufacturers continue to face. It’s worth noting that Fiat Chrysler still faces potential criminal charges for utilizing software alleged to defeat emissions testing protocols. In addition, some auto manufacturers are facing class action lawsuits over diesel vehicles that the plaintiffs allege used emissions ‘defeat devices’, as well as various other legal challenges.

Shift To Electrification Will Heighten Competition

Given that many recent events center around emissions, it’s no wonder that vehicle manufacturers are rapidly shifting towards electric vehicles. Indeed, Volkswagen – which suffered serious financial and reputational damage over its emissions scandal – announced earlier this week that it planned to meaningfully accelerate electric vehicle (EV) efforts. Tesla also announced that it’s slated to launch an electric SUV (Model Y) beginning in 2020. In our view, an accelerated shift towards EVs will result in heightened competition and weaker profitability at most legacy vehicle manufacturers because EVs have structurally lower profitability.

Investing Thoughts

While we continue to view certain automotive manufacturers as undervalued,this past week’s events underscore some of the risks these companies face. In addition, weakening economic growth, particularly in China, is likely to pressure vehicle sales in 2019. We therefore believe it is prudent to ensure equity positions in the automotive sector are sized appropriately to reflect these risks.