North American sales have remained resilient in 2019 and remain at healthy levels driven by the strong underlying U.S. economy (and consumer) and affordable gas prices. We believe profitability has been pressured by weak international results (primarily China) and higher commodity costs, though product mix (crossover sales) and looser financing terms have provided a partial offset. We expect headwinds to continue and volatility to remain high in the sector driven by concerns for global growth and ongoing trade wars (most recently Mexico). Longer term, we view the transformational risk as increasing due to the threat of electric vehicle (EV), autonomous vehicles and ride sharing.

Our Industry Assessment is supported by:

Level of Competition

The auto sector has large players with high barriers to entry, but pricing competition remains high (incentive spending is the rise) as companies fight for market share. Additionally, input costs have been trending higher. As such, margins have been under pressure the last few quarters.

Regulatory Environment

The current Administration is more accommodating towards auto companies as it relates to environmental standards. That said, we believe the longer term direction will likely be more restrictive as various environmental impacts are considered.

Activism

Cash flows have been under some pressure, but remain fairly balanced between capital returns.

Merger and Acquisition (M&A) Risk

The low M&A risk for original equipment manufacturers (OEMs) is offset by the ongoing strategic reviews in the high-yield and high-grade auto parts names.

Environmental, Social and Governance (ESG)/Transformational Risk

Long one of the main contributors to carbon emissions, the auto industry is undergoing a seismic shift in the production of vehicles. While the bulk of profits are still generated from traditional combustion engines, increasing amounts of capex are being redirected to EVs and mobility. Some notable, market-leading companies have provided aggressive production targets in an effort to trigger a broader, more rapid adoption. Key ESG Factors: Carbon and greenhouse gas emissions, fossil fuel dependence, climate change and renewable energy.

Position in Credit Cycle

Revenue growth has leveled off, but remains at very healthy levels. Concurrently, leverage has started to marginally increase.