In recent months, the automotive industry has been sending up flares of potential trouble ahead. Weak Q2 results for 2024 from several automakers have highlighted a decline in demand, raising concerns about an impending auto recession. Among the companies at risk, Tesla stands out due to its unique position and history. This blog post dives into the signs of an auto recession, why Tesla might be particularly vulnerable, and what this means for the future of the industry.
Early Signs of an Auto Recession
The early indicators of an auto recession are becoming increasingly clear. Various automakers have reported their Q2 2024 earnings, and the results are less than encouraging. Weak demand has been a consistent theme across the board, pointing to broader economic issues at play.
In fact, the 9 carmakers that have already reported missed Q2 consensus EPS estimates by an average of 12.8% and saw their share prices drop by an average of 7.6%. This downturn is a significant red flag for the industry, suggesting that consumers are tightening their belts when it comes to big-ticket purchases like cars.
Interestingly, while average Q2 revenue growth was up by 5.2% year-over-year, finished goods inventories were up by an alarming 13.9%. This disparity indicates that while cars are being produced, they aren’t being sold at the expected rate, leading to a backlog that could spell trouble for future production and profitability.
Weak Earnings Across the Board
The impact of weak earnings has been felt across the industry. Out of the nine carmakers that have reported, only GM and Renault managed to beat Q2 EBIT estimates. Four missed their targets, and three were in line. This uneven performance has led to a general sense of pessimism among investors.
Furthermore, only two carmakers have raised their full-year guidance, while four have lowered their targets and three remain unchanged. This cautious outlook is another indicator that the industry is bracing for tougher times ahead.
The average operating profit (EBIT) margins deteriorated from 9.3% in Q2 2023 to 7.9% in Q2 2024. Among the worst-hit were Nissan, Tesla, and Stellantis, while GM, Renault, and Kia managed to show some improvement. This decline in profitability is a worrying sign for the industry, indicating that even strong companies are struggling to maintain their margins.
Tesla’s Unique Vulnerability
Tesla finds itself in a precarious position amid these troubling signs of an auto recession. Since its IPO in 2010, Tesla has never had to weather a global auto recession. Now, with a 24% drop in sales in Q2 compared to the same period last year, the company is facing challenges it hasn’t encountered before.
In California, one of Tesla’s key markets, sales dropped by 17% in Q2 2024. This decline in one of its strongholds is particularly concerning for the electric vehicle giant. The lack of new models in its pipeline further exacerbates Tesla’s vulnerability. With a stagnant product lineup, the company may struggle to attract new customers and maintain its market share…and Cybertruck’s struggle to convert reservations isn’t helping.
Financially, Tesla is also showing signs of strain. The company started a new bank lending facility in China during Q2, a move that indicates it may be shoring up its finances in preparation for tougher times ahead. This financial maneuvering is a stark contrast to the company’s usual narrative of robust growth and innovation.
Morgan Stanley’s Contrarian Indicator
Morgan Stanley’s recent endorsement of Tesla as their “top pick” has ironically turned into a contrarian indicator. Historically, such endorsements have often preceded a decline in Tesla’s stock price. This pattern seems to be repeating itself, adding another layer of complexity to Tesla’s current situation.
Investors are increasingly skeptical, selling into whatever strength there is. This lack of confidence is reflected in the company’s falling share prices, which have not inspired the usual bullish sentiment among traders.
Broader Industry Trends
The broader automotive industry is also grappling with significant challenges. The over-capacity in the industry, combined with its capital-intensive nature, makes it particularly vulnerable during economic downturns. Even companies like GM, which reported strong Q2 results, saw their shares drop by 6.4% after reporting both a beat and a guidance hike.
Japanese carmakers seem to be better positioned to weather this storm due to their diverse global footprints and low inventories in the US. However, the strengthening yen poses a risk, given that most of their sales are overseas in foreign currencies.
In contrast, German carmakers are facing significant risks due to their heavy reliance on the Chinese and European markets, both of which are currently struggling.
The Role of Inventories
One of the most telling signs of an impending recession is the state of inventories. Finished goods inventories were up 13.9% year-over-year, a massive increase that indicates products are not moving as quickly as anticipated. This build-up can lead to a slowdown in production, further exacerbating financial woes.
For Tesla, this inventory issue is compounded by its lack of new models. Without fresh offerings to attract buyers, the company risks being stuck with unsold stock, which could lead to financial strain and potential layoffs.
Profit Margins Under Pressure
The decline in operating profit margins is a significant concern for the industry. Only three out of the nine carmakers that have reported so far saw their EBIT margins improve compared to Q2 2023. This decline in profitability is a worrying sign, indicating that even well-established companies are struggling to maintain their financial health.
For Tesla, which has always prided itself on its innovative edge and robust growth, this decline in profitability is particularly concerning. The company needs to find ways to improve its margins, either through cost-cutting measures or by increasing sales, to weather the potential recession.
Impact on Share Prices
The impact of these financial struggles is evident in the share prices of major automakers. Since reporting their Q2 earnings, all but Hyundai have seen their share prices drop, with an average decline of 8.5%. This drop reflects investor sentiment that the industry is heading into a challenging period.
For Tesla, whose stock price has always been volatile, this trend is particularly troubling. Investors are increasingly skeptical of the company’s ability to maintain its growth trajectory in the face of these challenges.
Japanese Carmakers’ Advantage
Japanese carmakers appear to be in a better position to handle the potential recession. Their diverse global footprints and low inventories in the US provide a cushion against the economic downturn. However, they are not entirely immune to risks, with the strengthening yen posing a significant threat.
The Japanese Big 3 have an average of 40 days’ supply in the US, compared to Ford’s 89 days and Chrysler’s over 100 days. This lower inventory level gives them more flexibility to adapt to changing market conditions and reduce the financial strain of unsold stock.
German Carmakers’ Struggle
In contrast, German carmakers face significant risks due to their heavy reliance on the Chinese and European markets. These regions are currently among the worst-performing in the global auto market, making it difficult for German companies to maintain their sales and profitability.
This reliance on struggling markets, combined with their high production costs, makes German carmakers particularly vulnerable to the potential recession. They will need to find ways to diversify their markets and reduce costs to mitigate these risks.
The Importance of New Models
The introduction of new models is crucial for maintaining consumer interest and driving sales. Unfortunately, Tesla currently lacks new models in its pipeline, which puts it at a disadvantage compared to competitors who are regularly updating their offerings.
Without new models, Tesla risks losing its edge in the market and may struggle to attract new customers. This stagnation could lead to a decline in sales and profitability, further exacerbating the company’s financial challenges.
Tesla’s Financial Maneuvering
Tesla’s recent financial maneuvers, such as starting a new bank lending facility in China, indicate that the company is preparing for potential financial strain. These moves suggest that Tesla is aware of the challenges ahead and is taking steps to shore up its finances.
However, these actions also highlight the company’s vulnerability. Financially strong companies typically do not need to make such moves, indicating that Tesla may be more exposed to the potential recession than it publicly acknowledges.
Conclusion
The automotive industry is sending clear signals that a recession may be on the horizon. Weak Q2 results, declining profit margins, and rising inventories all point to challenging times ahead. Among the companies at risk, Tesla stands out due to its lack of new models, financial maneuvering, and declining sales.
For auto enthusiasts and investors, these developments are worth monitoring closely. The potential recession could reshape the industry, presenting both challenges and opportunities for those who are prepared.
