Wells Fargo Senior Analyst Colin Langan joins Yahoo Finance Live to discuss the state of the auto industry, the EU energy crisis, how automakers are dealing with supply chain disruptions and inflation, the EV tax credit, and the outlook for the auto industry moving into 2023.

Video Transcript

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JULIE HYMAN: Automakers are revving up for the new year, but our next guest says investors should still expect choppy waters or perhaps bumpy roads ahead with inflationary prices and volume declines still weighing on the sector. Wells Fargo senior analyst Colin Langan is joining us now with his outlook for next year. Hey, Colin, good to see you. And you basically, when you're looking at the whole of the industry and what sales we could expect next year, you think that the consensus is a little bit too optimistic. Talk to us about your targets and why you think that they're going to be lower than perhaps what the street's pricing in.

COLIN LANGAN: Yeah, absolutely. I mean, I'm about I think on average, if I look at the core metrics, about 9% lower on 2023 than most of the traditional supplier and OEM estimates for next year I think there's really two key drivers that I think about.

One is just light vehicle production. I think we're expecting just 2% year-over-year growth really with a lot of concerns driven out of Europe and China. China's actually already above where they were before COVID and they had some incentives this year. I think there'll be payback.

And I'm still very wary of the Europe energy crisis and what that might do to the consumer over there or just potentially slight disruptions given the supply chain could cause some production blips. So I think we're going to see more conservative, particularly from the suppliers, guiding on production year over year to be much lower than what people are baking into their numbers now. I think the benchmark tends to be around 4%.

And then secondly, I think people are expecting, particularly for the suppliers, this inflation recovery tailwind from 2022, inflationary costs into '23. I think that's absolutely going to happen. I think what they're underestimating is the continued inflation into 2023.

And we're already seeing January 1, there'll be a 20% minimum wage increase in Mexico. That's a big hub for labor for suppliers and so already day one we're going to have inflationary wage pressure. So there's already signs before we even started the year that pressure is going to be there again. And we're very worried about pricing for the automakers. And if they're under pressure for profits because pricing is coming down, it's going to be harder to get concessions for those costs from the automakers.

- So do you believe the automakers' earnings estimations already priced this in or does there need to be another revision to the downside on this?

COLIN LANGAN: I think there's significant downside to the OEM. So we're underway both GM and Ford. I think pricing is just in there-- hasn't even started yet. And I think it's going to be a continual drag as we go through next year.

There's already signs that pricing is under pressure. We've looked at the last six months, if you look at the absolute unit sales are fairly flat in the US, but inventory is up about a half a million units. Not a good sign.

Some of that might be in transit, but we're still not seeing the as it was, at, sort of, the peak demand levels where the minute it hits the dealer lot, it gets pulled away. Now it's starting to stick. We also saw there's data out there saying that dealer profits are down 15% in November year over year, which is really showing they're starting to sell more vehicles below MSRP, which I think is the sign that pricing is starting to correct. So it starts with the dealers, then it'll hit the OEM since they start upping their incentives.

BRIAN SOZZI: Colin we got news this morning that there will be a delay or likely a delay till March next year in the new $7,500 EV tax credit. How big a problem will that be to the first half for Tesla?

COLIN LANGAN: I mean, the way I understand the rules is actually with this delay, it's only delayed a part of the rule. And it's still very unclear quite frankly. But my understanding is that it's part of the rule and they actually might benefit from this because there's up to $7,500. I actually think they'll only get half of that for the battery component, which is $3,750.

The interpretation that's out there is that until the rules are actually implemented, you don't have to meet those requirements, but the rules will be effective. So I actually don't know that it necessarily is going to be a bad news for Tesla. Actually, I think there could be extra credits available maybe for the first three months of the year.

JULIE HYMAN: I do want to pick up on Tesla, Colin, because you didn't talk a lot about Tesla in your outlook for next year. But obviously, it's been very much in the news. The stock has not been doing well as of late although it did initially pop a little bit yesterday on the thinking maybe Musk was going to step away from Twitter. We've talked to you a little bit before about his sitting in many seats, wearing many hats, et cetera. What's your current thinking on the situation?

COLIN LANGAN: Yeah, I mean we remain equal weight. I think there's clearly pros and cons to the stock. I mean it's very concerning about the weakness that we're seeing in China. We're seeing incentives go up and sales actually are not increasing there.

And there's driving concern is are we going to start seeing that in the US and Europe? Is that just, sort of, the early days of softening demand? And I think that is really more of the large institutional investors top concern.

I think for Twitter, everyone, I think, has seen that Elon could multitask. So the actual multitasking is not something I think traditional institutional investors are that concerned about. But I do think there's a little bit of rising concern about maybe potential brand damage from some of the headlines that are coming around the Twitter situation. I think it's very, very unclear at this point if that's having a meaningful impact, but I think we'll see how it all resolves.

But as you go into next year in terms of good news, the IRA is going to be a nice help. Tesla and GM are probably the biggest beneficiaries of-- almost certainly the biggest beneficiaries of IRA. And that should result in a nice quick boost in demand as all of a sudden the vehicles get cheaper because of these tax credits.

- Colin, give us more good news. What's your top pick for 2023?

COLIN LANGAN: I mean I continue to like BorgWarner. It's a supplier that is, I think, going to be a leader in the transition from internal combustion engine to EV. It's trading at a discount to the group and yet I think it'll be by 2025 one of the, sort of, top two or three global e-powertrain suppliers.

They're going to do a spin of some of their internal combustion engine businesses that I think have a really good free cash flow profile that support that valuation. But the remain co after they have to spin will have 6% above market growth, which is going to be one of the top among the supplier group. It'll have margin expansion as they start scaling their EV from about $850 million to $4 billion by 2025. So I think there's good near-term and long-term story here for the company.

BRIAN SOZZI: Wells Fargo senior analyst Colin Langan, always good to see you. Happy holidays.

COLIN LANGAN: You too.