US Automotive Sector at Crossroads: Key Insights

By Shawn Lee, CFA , Portfolio Manager, SGH Australian Small Companies Fund

Welcome to our US Market x ASX Small Caps Series

As part of our ongoing commitment to delivering valuable insights to Australian investors, Shawn Lee, Portfolio Manager of the SGH Australian Small Companies Fund, recently embarked on an extensive research trip across the United States, meeting with over 40 companies spanning critical sectors like technology, automotive, insurance, and healthcare. This series unpacks the essential takeaways from those conversations, providing a closer look at how American businesses navigate challenges such as inflation, labour constraints, regulatory risks, and the fast-approaching U.S. presidential election. In each article, we explore a specific sector, connecting the dots to help you better understand the opportunities and risks on the horizon.

Stay tuned as we explore each sector, from stocks making waves to advancements in AI and more.

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The automotive sector faces a confluence of structural and cyclical headwinds that could significantly impact both U.S. and Australian markets. During our research trip, we visited over 40 companies, including several large U.S. automotive dealers and auto parts retailers, to understand industry trends. Our insights from conversations with industry executives paint a complex picture of the challenges and opportunities ahead for the auto sector.

Dealer Margins Under Pressure

U.S. auto dealers are facing a gradual erosion of the inflated margins they enjoyed during the pandemic. Dealer gross margins are declining with the supply of new cars normalising to pre-pandemic levels. During our meetings with leading U.S. retailers like Lithia Motors, Sonic Automotive, and TrueCar, it became clear that industry consolidation remains a long-term growth driver, whilst the near-term outlook is more uncertain.

Evidence suggests that new car gross margins will continue to decrease as sales volumes level off amid weakening consumer sentiment. This trend has already been mirrored in the domestic market, with Australian auto retailers such as AP Eagers and Peter Warren Automotive recently reporting weaker trading environments. While the benefits of network consolidation and higher finance & insurance penetration may help cushion some of these impacts, a more pronounced rebasing of margin expectations could be on the horizon.

Consumer Affordability Stretched

Another critical insight from our trip was the strain on consumer affordability. High interest rates are limiting consumers' ability to finance new vehicle purchases, and while rate cuts may offer some relief in the future, the broader economic environment remains challenging. U.S. automotive sector executives noted that automakers must increase discounts and incentives to maintain sales volumes, which will further pressure margins across the value chain. This reliance on supplier discounts is expected to continue, presenting significant challenges for U.S. and Australian auto markets.

Maintenance Spending Shows Resilience, But Cracks Emerge

The automotive maintenance sector has traditionally shown resilience during economic downturns, and our meetings with executives from U.S. auto parts retailer Autozone confirmed that this remains true, albeit with some signs of weakness. While core maintenance categories are holding steady, discretionary spending on items like seat covers and floor mats is softening. Autozone highlighted that, in challenging economic cycles, consumers tend to shift away from expensive Original Equipment Manufacturer (OEM) dealerships toward more affordable options such as DIY repairs or local mechanics.

This shift presents opportunities and risks for Australian aftermarket retailers like Bapcor and Supercheap Auto, which could benefit from increased demand for lower-cost repairs. However, the overall outlook remains cautious as the macroeconomic environment pressures consumer spending.

The Rise of Hybrids Over EVs

While electric vehicle (EV) penetration remains relatively low in the U.S. (around 7% nationally and 15% in California), we observed a growing trend favouring hybrid vehicles. Concerns over EV range, battery lifespan, and resale values continue to deter consumers from fully embracing electric cars. Instead, hybrids are gaining traction, partly due to government incentives and the perception that they offer a more reliable and cost-effective solution.

This shift toward hybrids is also happening in Australia, where similar tax incentives and consumer anxieties influence purchasing decisions. Dealerships stand to benefit from this trend, as hybrids have better availability and require more frequent servicing, offering an additional revenue stream for dealers.

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Thank you for reading US Automotive Sector at Crossroads: Key Insights, the fourth article in our US Market x ASX Small Caps Series.

If you’re interested in exploring more, be sure to check out our previous articles, including ASX Stocks Making Waves in the US, Artificial Intelligence Innovations and our US Market Outlook. Stay tuned for our next article in the series, covering the Medtech Sector.

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