As GM (NYSE: GM) celebrates an impressive re-entry into the public markets, investors are chewing over a clear theme. Both GM and Ford (NYSE: F) are far healthier companies, with much leaner cost structures and the ability to generate sharply improved profit margins as industry volumes rebound. In their shadow, key auto parts suppliers are also now in fighting shape after being bruised and battered in the economic freefall of 2008. The new adage for the industry: “what doesn't kill you makes you stronger.”
How bad did it get for these auto parts suppliers? Domestic auto makers produced 15-16 million cars and trucks every year from 2001 to 2007. That figure fell to 12.5 million in 2008 and just 8.5 million in 2009. Years of steady profits were offset by massive losses in 2008 and 2009, and a number of these firms flirted with bankruptcy. For a short while, many of their stocks traded below $1. In a testament to just how much they have changed, all of the key players are likely to be nicely profitable again this year, even though the industry will produce just 11.5 million units.
Looking ahead into 2011 and 2012, industry unit volumes are expected to rebound to 12.5 million and 13.5 million, respectively, according to Citigroup. And that could prove to be conservative. That's because domestic auto makers are starting to take back market share, which means a rising swell of business for the firms that make seats, transmissions, suspensions and the like.
Shares of auto suppliers have rallied sharply in the past year, but remain very reasonably priced in relation to earnings…
With GM's successful IPO in the news, customers may start to flock back to the auto maker in droves, now that they see it as healthier. That hasn't been the case recently. Ford announced that October sales rose +19% from a year ago, while many other auto makers also posted double-digit gains. GM saw a more modest +3.5% sales boost in October.
As a self-professed car nut, I had been a big fan of Ford Motor, noting that its new models were compelling and should yield market share gains. [Read my analysis here]
These days, I'm starting to pay closer attention to GM as it starts to build out its impressive new product portfolio. The Buick division is a big hit in China, Cadillac is unveiling a strong set of new cars that can go head-to-head with anything made in Germany, and the Chevy and GMC truck divisions should eventually see a major profit rebound when the U.S. construction industry picks back up.
But rather than buying shares of GM, you might want to focus on the auto parts suppliers with the greatest exposure to this erstwhile titan. Shares of many of these names remain cheap, and a resurgent car market could lead these stocks to nice gains.
Here are a few key names…
If you're talking about GM's pickup trucks, then you're talking about Lear (NYSE: LEA), which makes seats and electrical systems for GM's GMT 900 truck platform. Lear has been on a tear lately, delivering quarterly profits that were more than twice as high as analysts had expected in each of the past two quarters. A -$2.00 a share loss in 2009 is likely to morph into an $8.00 a share profit this year. A little back-of-the-envelope math that assumes industry volume hits 14 million by 2013 could yield earnings per share (EPS) north of $12 for Lear. Shares trade for just seven times that view.
American Axle (NYSE: AXL) has even greater exposure to GM, with more than two- thirds of its business from the company. (It was once an in-house division at GM.) The company makes axles and drivetrains, primarily for large vehicles. The company has also handily exceeded forecasts in each of the past two quarters and also notes that backlog is rising fast. That led JP Morgan to recently upgrade shares to overweight, with a $14 price target — +25% above current levels. Yet the analysts note that shares could surge closer to the $20 mark within a few years as GM's sales volume rebounds. They add that American Axle is on track to boost EBITDA +30% next year to around $370 million, and it could hit $500 million within a few years.
Action to Take –> Tenneco (NYSE: TEN) and Johnson Controls (NYSE: JCI) also have a high degree of exposure to GM. As noted earlier, all of the shares in this sector have rallied throughout 2010, and would be vulnerable to a pullback if auto and truck sales don't continue to rebound in 2011 as many expect.
Stocks in this group appear quite inexpensive, especially in terms of potential EBITDA generation. How auto industry sales fare in the next few years will determine how much more upside these stocks have.
– David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…
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GM’s Back — And So Are These Key Suppliers