Three big things in auto: China may win on EVs, ICE suppliers are undervalued and AI is in the mix

The thunderbolts keep hitting in the automobile sector as investors scramble to find a smooth ride.

Morgan Stanley believes that Tesla (NASDAQ:TSLA) and other Western automobile firms have come to a unanimous and simultaneous realization that China has won the contest for electric vehicle supremacy. "From this point, the industry is likely to enter a new phase of capex spend (lower), protectionism (higher) and cooperation with China (eventual)," noted analyst Adam Jonas. Tesla's (TSLA) partial pivot to focus on autonomous driving and a robotaxi fleet could support that contention. General Motors (NYSE:GM) and Ford (F) have pulled back on their aggressive EV targets, while Rivian Automotive (RIVN) and Lucid Group (LCID) are struggling to reach the break-even point as soon as investors would like. In the latest development, Ford Motor (F) is reportedly cutting battery orders due to heavy losses. Meanwhile, the Biden Administration is expected to announce a four-fold increase in tariffs on EVs imported from China in an effort to shield U.S. carmakers from cheap Chinese clean-energy products. The decision follows a review of Trump-era "America First" tariffs on Chinese imports that included steel, aluminum, solar panels, and home appliances, among others.

The reset for investors is that the logic for exposure to ICE/hybrid-exposed names or powertrain agnostic players is on the rise as EV strategies hit the brakes and hopes for the great Green Tidal Wave fade. At the moment, the automobile industry may have the lowest collective multiple in the market, despite having some of the best use cases for AI. "The nearly 12 trillion global miles traveled per year (380k miles/second or >2x the speed of light) can capture some of the most valuable visual data in the Gen AI/Robotics space. The tension is palpable," wrote analyst Adam Jonas. Suppliers like Magna International (MGA) have also pointed to significant AI potential in manufacturing. Notably, Magna (MGA) has highlighted that leveraging AI can provide human operators with enhanced information for decision-making, and it can automate quality, sorting, and material handling to help reduce production costs. AI-enhanced predictive maintenance systems are also seen as enabling effective error-free maintenance of equipment, which ensures higher machine uptime. The boost in efficiency for auto suppliers is seen as padding margins down the road to a greater degree than in most industries.

During the Q1 earnings season, suppliers American Axle (AXL), BorgWarner (BWA), and Phinia (PHIN) were the three major suppliers that beat consensus revenue estimates and reiterated full-year guidance. Notably, all three are ICE-skewed. "Looking forward, as EV-exposed platforms miss and ICE-exposed platforms beat, we expect to see greater parity between EV and ICE-skewed names," advised analyst Adam Jonas. The firm said it was encouraged by announcements to increase shareholder cash return while dialing back on EV/AV initiatives from both BorgWarner (BWA) and Aptiv (APTV). Looking ahead, ICE-skewed suppliers such as American Axle (AXL), BorgWarner (BWA), Magna International (MGA), and Phinia (PHIN) are seen outperforming the market. Morgan Stanley upgraded Lear Corporation (LEA) to an Overweight rating due to a combination of portfolio resiliency, capital efficiency, and valuation.

Morgan Stanley's top ten picks in the auto sector in order of preference are Ford Motors (F), Tesla (TSLA), Ferrari (RACE), Phinia (PHIN), General Motors (GM), CarMax (KMX), American Axle (AXL), Avis Budget (CAR), BorgWarner (BWA), and Magna International (MGA). Top global picks include Michelin (OTCPK:MGDDF) (OTCPK:MGDDY), Honda Motor (HMC), Zhongsheng, CATL and Toyota Industries (OTCPK:TYIDY) (OTCPK:TYIDF). In terms of quantitative analysis, the list of auto-related stocks with a Seeking Alpha Quant Rating of Buy includes General Motors (GM), Volkwagen (OTCPK:VWAGY), BYD Company (OTCPK:BYDDF), Modine Manufacturing (MOD), Dorman Products (DORM), Gentherm (THRM), Autoliv (ALV), Aptiv (APTV), Gentex Corporation (GNTX), and Garrett Motion (GTX).