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2 reasons I’d steer away from these auto stocks this summer

In this century I have found that the automotive industry has served as a solid barometer for the broader economy. It is a critical driver of economic growth on its own, making up 4% of the GDP of the United Kingdom according to the Society of Motor Manufacturers & Traders (SMMT). The automotive sector also makes up a whopping 12% of UK exports.

This broad exposure is one of the reasons I am steering clear of the sector this summer. Today I am going to go over two reasons I’d look elsewhere right now.

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UK auto sales in decline

Consumer spending in the United Kingdom started poorly this year but improved in the three months into April 2019. Retailers and analysts credited warmer weather and higher earnings for the bump. The story has been different for automobile retailers. In May, the SMMT said that car sales fell by 4.6% year-over-year to 183,724 units. This came after new car sales fell by 4% in the month of April, which was the second-slowest April since 2012. Poor auto sales have been a familiar sight in the developed world in the last two years.

Auto Trader (LSE: AUTO) stock had climbed nearly 30% in 2019 as of close on June 18. The company has attracted the ire of some traditional motor dealers in the past due to costs related with the use of its highly successful platform. A challenging market environment is making margins tighter for Auto Trader, and it will need to capture a greater proportion of revenue opportunities going forward in order to achieve its growth targets.

Auto Trader stock had a prolonged brush with technically oversold levels from mid-March into early May. Its post-earnings dip may entice some investors, but I am staying away from Auto Trader at current price levels.

The Brexit threat

The shadow of Brexit looms large over the auto industry. A no-deal Brexit would trigger a 10% initial tariff on British autos. The SMMT has not been shy in strongly advocating against a no-deal Brexit. In March it released a list of “13 automotive Brexit myths”. The main concern surrounds auto manufacturing, but dealers could suffer immensely if a no-deal Brexit plunges Britain into economic turmoil.

Pendragon (LSE: PDG) is engaged in the retailing of used and new vehicles as well as the service and repair of vehicles after sale. Its shares plunged to a six-year low after its most recent earnings release. Weak demand in new and used cars prompted the company to warn of a pre-tax loss for the full year. The news is worse considering Pendragon had hoped that 2019 would provide stability after a difficult 2018.

Tumultuous conditions in the auto sector remain a significant concern, but Pendragon may seem alluring to some income investors. The stock is hovering around a 52-week low and dipped below 30 on the Relative Strength Index after its earnings release. Shares were technically oversold as of close on June 18. It last paid out a dividend of 0.70p per share, which represents a tasty 9% yield at the time of writing. At a glance Pendragon looks like a sneaky value play, but broader headwinds are too troubling for me to consider picking it up.

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Ambrose has no position in any of the shares mentioned. The Motley Fool UK has recommended Auto Trader and Pendragon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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