GM Bankruptcy: Time for New-Era Auto Opportunities

Includes: ALV, DORM, GM, GPC, LKQ, SUP
by: Marc Gerstein

General Motors (NYSE:GM) filed for bankruptcy. The sun is still shining. The air is still breathable, or at least no less so than yesterday. The water is still wet. The earth is not shaking. Our economy is still capitalist (true the U.S. will get a 60% stake in GM but seriously, anybody who has trouble distinguishing between Obama on the one hand and Marx, Engels, Lenin, Trotsky, Stalin, Mao, etc. on the other has bigger problems than the stock market to worry about). And by the way, the beat-up minivan I’m driving is not getting any younger.

How will the GM filing impact the auto industry? Who knows. There will be lots of opinions and by the time the debate cools, enough time will have passed that all we’ll have to do is look around and see what happened.

How will the GM filing impact auto-related stocks. In some respects, this, too, is hard to assess right away since a complete answer will require an understanding of what will happen to the companies. But with the stock market, we can profit from partial answers. And with regard to the latter, there is one thing we do know: a massive sources of uncertainty (whether GM continue to exist at all) has lifted.

Since Wall Street hates uncertainty so much, perhaps even more than bad news itself, this alone should be good for auto-related stocks. Adding spice is the increasing likelihood that the worst economic news is already out there and that subsequent developments will probably, even if slowly, better.

Based on the here-and-now emotional prop and the unfolding economic factors, this may be a good time to look for auto-related investment plays. One obvious answer involves shares of other manufacturers. These are big name companies whose stocks are likely to reflect the totality of Wall Street expectations quickly. And that’s fine. One can certainly ride a clearly-visible wave.

Looking at auto parts

Today, however, I want to explore another approach, searching for lesser-known auto plays that are likely to (1) benefit from any positive sentiment toward the group as a whole, and (2) potentially reap an additional benefit as more investors tune into these situations. For this reason, I decided to focus on auto parts.

There are two broad sub-groups here: original equipment (components used by auto manufacturers to produce new cars), and replacement (components used to repair older vehicles).

Traditionally, original equipment was seen as purely cyclical (stronger economic trends lead to increased demand for new cars) while the replacement market was assumed to have a defensive quality (when times are tough, people will spend more to keep old clunkers going). I tend to prefer the view that sees the replacement parts business as being fairly cyclical in its own right. Economic trends influence miles driven (and, hence wear and tear) was well as the willingness and ability of consumers to address maintenance issues that fall into the discretionary category. I don’t mean to suggest that replacement is exactly as cyclical as original equipment, but I do think, at this time, I’d be better served focusing on the extent of the company’s focus on auto parts (e.g., the pure play, versus the firm that gets, say, only 10% of sales from this area), and the fundamental merits of the company itself, rather than the distinction between original equipment and replacement parts.

Putting Portfolio123 to work

This endeavor seems made to order for stock screening: look for auto parts companies that meet certain criteria relating to P/E, growth, financial strength, etc. A few years ago, that’s exactly what I would have done.

This time around, however, I’m going to rely entirely on multi-factor ranking. I’m going to start with a ranking system I already built using I refer to it as the P123 Balanced system, and you can find out more about it by looking at the Appendix at the bottom of this prior Seeking Alpha article. I refer to the model as being balanced because it uses a somewhat large number of different factors spread across four categories (Growth, Company Quality, Industry Strength and Value). Many investment gurus and teachers suggest you should pick a clear style and stick with it. I prefer a broader approach. I’d rather not pre-judge which way, among the many possible ways or combinations of ways, a stock can demonstrate investment merit.

After applying certain basic liquidity constraints (no OTC stocks, market caps of at least $250 million, and share prices of at least $5), I note that there are 16 companies in the Auto & Truck Parts Industry. I sorted the ranks from best to worst and chose to look at companies in the top half.

Figure 1 shows how this ranking system has performed in a backtest. I separated the liquid portion of the relatively small Auto & Truck Parts industry into two components. The green line represents the performance of stocks ranked in the upper half. The blue line represents the bottom half. Finally, the red line depicts the path of the S&P 500. (Note: the test assumes rebalancing every four weeks.)

Figure 1

No way this can support buy-and-hold! The better-ranked stocks got pummeled when the market soured. That should not be a surprise. This is a cyclical group and as such, industry financials can and do turn very sour.

But I’m not presenting this group today as a bear-market play. The core of any investment case we might make here requires an assumption that we’ve turned the corner and are looking at better times ahead. Under conditions like that, auto parts stocks ranked in the upper half of the group have done very well in the past, and that’s even been the case in recent months. (Meanwhile, the lower ranked group has been a consistent laggard.)

The Stocks

Among the top eight, here are the five stocks that struck me as the purest plays on replacement parts in order of their scores (100=best).

  • Dorman Products (NASDAQ:DORM), Rank = 96.67
  • LKQ Corp (LKQX), Rank = 74.46
  • Genuine Parts (NYSE:GPC), Rank = 71.68
  • Autoliv (NYSE:ALV), Rank = 61.03
  • Superior Industries (NYSE:SUP), Rank = 42.85

I suppose I should not be surprised to find that even within this small industry sub-set, the two original equipment firms, ALV and SUP, rank lowest.

Here are rundowns on each of these situations.

Dorman Products (DORM)

This replacement-parts company has about as mundane a product line as I can remember having ever seen: hardware, fasteners, electrical parts, brake parts, clutch hydraulic parts, door handles, tailgate parts, and so forth. Some may take that as a negative. In this regard, I prefer the Peter Lynch doctrine to the effect that a “company that does boring things is almost as good as a company that has a boring name, and both together is terrific.” One Up On Wall Street, page 138.

The only interesting thing about this small company (it passed the $250 million market cap requirement by the skin of its teeth when I ran the model) is its financial performance, which has been terrific relative to peers for a long time.

Here is a summary of the rank components as of 5/30/09 as well as at three month intervals over the past year.

I wouldn’t go overboard about the 91.97 score for EPS growth in the latest period; it looked like a low tax rate offset lackluster cyclical performance in the basics. But even in past periods when that prop was not present, DORM still managed to post consistently high overall scores.


Another attribute I love to see in a stock, besides monotony, is a niche (this, too, being a favored Lynch characteristic). Within auto parts LKQX is definitely fits that profile.

It sells to collision repair shops. (In terms of business cycle, we have to assume better economy means increase in miles driven which leads to an increase in accidents). A large portion of LKQX’s product line consists of recycled parts. The rest are replacement parts manufactured by independent firms (i.e. those not connected with any original-equipment activities). Either way, LKQX sells cheap and this trait endears it to insurance companies who, by and large, drive the collision repair process.

Here is a summary of the rank components as of 5/30/09 as well as at three month intervals over the past year.

The company has grown by acquisition, which added debt to the balance sheet. We’ll have to watch how this plays out going forward. But when it comes to balance-sheet risk, it seems as if the worst-case scenario (a recession) has already happened – LKQX survived nicely – and that things are likely to improve going forward.

Genuine Parts (GPC)

If one were to make a list of beverage companies, you’d pretty much have to assume Coke would be on it. In auto parts, that’s the kind of stature enjoyed by GPC. Fortunately for those interested in this industry, GPC also ranks in the upper half.

Rather than manufacturing, GPC earns its living as a distributor of replacement parts to independent repair shops, who are well acquainted with its NAPA brand and many of whom appreciate the inventory management services GPC provides.

This is not an easy business to be in. With extended warranties, auto companies are trying hard to keep customers coming back to dealerships. On the other hand, the number of dealerships is likely to diminish as the auto industry restructures.

Here is a summary of the rank components as of 5/30/09 as well as at three month intervals over the past year.

In terms of financial strength, this company is actually pretty consistent and reasonably solid. This rank is computed only relative to others in this small industry many of which are manufacturers with higher fixed costs and, hence, more need to reduce debt levels.

Autoliv (ALV)

ALV, the higher ranked among my two original equipment companies, is actually the anti-Dorman. As auto parts go, its business is actually among the more interesting.

The company is a leader in safety equipment such as seatbelts and airbags. That stuff, in this day and age, is old hat. But safety-conscious consumers and payout-conscious insurance companies are demanding more and that’s what they’re getting from ALV: a newer generation of products such as side airbags and safety electronics. These are not nearly as widespread as the basics, so ALV can aspire to the auto parts dream: above-average growth based on an increase in the dollar-content of company product on each car.

Here is a summary of the rank components as of 5/30/09 as well as at three month intervals over the past year.

The growth scores clearly reflect the downside of being an original equipment supplier. No matter how great a product line you have, if the number of cars produced falls, you’re going to take it on the chin. Needless to say, anyone considering ALV stock at this time should be assuming we’re at or near a trough and that things will look better going forward.

Superior Industries (SUP)

As a play on supplying components to the Big Three, this producer of aluminum wheels is as classic as you can get, for better or for worse.

In recent years, SUP has been hit with plenty of the “worse.” Auto production in general has plummeted. The Big Three was especially hard hit. And naturally the latter demanded brutal price concessions from suppliers like SUP. Skipping all the gory details, let’s just say it takes a lot to get a growth score of just 4.07 (on a zero to 100 scale), such as we see below in the summary of rank components.

Fortunately for SUP, there are reasons to look for better times ahead.

First, as mentioned previously, there is the likelihood of cyclical improvement. Second, there appears to be a limit as to how far the carmakers can push in terms of price. When it comes to wheels, SUP is a very large supplier; i.e. one that can deliver the quantity that’s needed at the time when it’s needed. Smaller rivals in the U.S. and overseas can’t always match that. And finally, it isn’t as if SUP hasn’t been doing what it can to help its own cause. A debt-free balance sheet helps whether does times, as do the efficiency programs (e.g. automation) the company has been implementing.

Disclosures: None