Published July 16, 2013
Goldman Sachs (GS) downgraded the U.S. auto sector on Tuesday for the first time since the end of the Great Recession due to concerns about rising interest rates and less attractive valuations.
Overall, Goldman cut its rating on the auto sector to “neutral” from “attractive,” highlighting the fact that auto equities have underperformed the S&P 500 by an average of 26% in three of the last four interest-rate tightening cycles.
“The sector’s growth outlook for the balance of this cycle appears to be now largely discounted in the shares just as we enter into a phase of tightening long rates, which has typically been negative for auto valuations,” Goldman analyst Patrick Archambault wrote in a note to clients on Tuesday.
The performance during periods of rising interest rates helps explain why the auto sector has historically peaked 65% of the way through an expansion, the report said.
This marks the first time since June 2009, during the early days of the current recovery from the 2008 financial crisis, that Goldman has removed its “attractive” rating on the group.
"We believe this justifies a more balanced sector view, which, if anything, puts the emphasis on stock picking over a broad sector call,” Archambault wrote. “The best opportunities in our view remain product cycle stories like Ford and GM, which can see share and pricing gains that are incremental to a macro driven volume recovery.”
With that in mind, Goldman said its new “favorite name” is GM, which it added to the Conviction Buy List with a $45 12-month price target, implying 24% upside from Monday’s close at $36.50.
The bank highlighted GM’s revamped global portfolio, which is set to fall to an average age of 4.3 years by 2016 from 5.3 years today.
Also, GM should benefit from the fixed-income fluctuations because the auto maker is “significantly leveraged to rising rates,” Archambault wrote, saying the current Moody’s AA index yield implies an additional $6 billion in equity value amid shrinking pension obligations.
Following the upgrade, shares of GM hit a new 52-week high of $36.94 Tuesday morning, although they were recently trading down 0.19% to $36.43.
On the other hand, Goldman removed Ford from its Americas Conviction List due to the fact the auto maker’s stock has outperformed GM’s 33% to 27% so far this year.
Still, Ford is seen as offering “among the best growth prospects in the sector” thanks to the housing recovery driving North American pickup demand, the company’s “aggressive turnaround plan” in Europe and a product-driven rebound in Brazil and Asia. Also, the tightening rate environment should reduce Ford’s net liabilities by $1.9 billion, Goldman predicted.
Dearborn, Mich.-based Ford slumped 2.04% to $16.76 Tuesday morning after the downgrade, trimming their 52-week surge to 84.9%.