Sector outlook: Autos

Sectors in-the-know investors will definitely want to keep an eye on

With all due respect to B.C.-based Ballard Power Systems, when people talk about the Canadian vehicle industry, they mean automakers and part manufacturers in Ontario, which rolled over Michigan as an auto-making region in recent years by feeding American demand for SUVs.

Unlike Michigan, Ontario benefited from an infusion of Asian blood (read: Toyota and Honda) that has offset the downsizing of Big Three operations. But let's be clear: General Motors, Ford and DaimlerChrysler have not abandoned the land of relatively efficient workers, not to mention free health care. Canada is still a great place to make cars and light trucks. That's why it has attracted billions in new investments despite a stronger loonie.

What about tomorrow? If you believe the Conference Board of Canada, our auto sector will see an increase in profitability in 2007, as “the dollar falls, making Canadian-made vehicles more competitive.” The board projects margins, which currently sit under 1%, will hit 2.9% by 2008. The problem, of course, is that leading sector watchers don't believe the board, and not just because the Canadian dollar could hit new highs in the future (see story on page 42).

“They are smoking those funny-looking cigarettes,” says auto analyst Dennis DesRosiers. He notes that Canada exports close to 90% of vehicle production and about 80% of parts production to the U.S., which can no longer rely on industry incentives and consumer mortgage refinancings to pump up demand. “Take away the two most significant upside variables to vehicle sales,” he says, “and the U.S. market is looking very soft for the next two, maybe three years”–with declines in the high single-digit range. Add in an expected further decline in Big Three market share, and “the outlook is not the best for most of the Canadian auto parts sector since they are highly reliant on these three companies.” That's why even the best-run players like Magna International are restructuring as fast as they can.