Tough Times for Auto Parts Makers Should Continue

Includes: JCI, MGA, TRW
by: Investopedia Advisor

Investopedia Advisor submits: Though share prices are attractive for auto parts makers, the long-term outlook warrants caution.

Blame it on higher gas prices, the housing bubble bursting or the possibility that creeping inflation might yet push interest rates higher. Whatever the reason, U.S. consumers continued to stay away from North American car dealerships last month in droves, and sales for the big three U.S. car makers once again disappointed.

With a product line-up top heavy with big, gas guzzling SUVs and light trucks, the sales numbers for Ford (NYSE:F) were down the most -- off 11.6% compared with the same month a year earlier. Daimler Chrysler (DCX) did somewhat better with only a 3.2% drop and General Motors (NYSE:GM) managed to make it into the plus column with a relatively anemic 3.9% gain. When compared to the 17% sales increase reported by Toyota (NYSE:TM) over the same period, it’s clear that the U.S. auto makers have yet to find their game in an increasingly tough marketplace.

While this is certainly bad news for shareholders in these companies, it’s also bad for another group of stakeholders in the major U.S. auto makers – the OEM auto parts suppliers. Companies like Johnson Controls (NYSE:JCI), Magna International (NYSE:MGA) and TRW Automotive Holdings (NYSE:TRW) have all seen their share prices slump so far this year as the prospects of their number-one customers continue to deteriorate.

Production cuts at Ford, which are expected to be a whopping 20% in the fourth quarter, are already being felt across the auto parts industry. Yesterday, management at TRW did an about-face and lowered their earnings guidance for this year after having raised it as recently as last month.

The reason cited was lower production of Fords’ F-1 series trucks and higher materials costs. This somewhat surprising admission from management was enough to bring on a quick sell-off in the company’s shares, which at one point were down 5% before closing with a 2.4% loss on the day of announcement.

Despite all the obvious signs of weakening fundamentals and growing investor nervousness about the sector, Wall Street’s analyst community continues to recommend auto parts stocks citing the usual mantra of “positive long-term outlook” and more “attractive valuations” now that share prices are down roughly 15% from their highs earlier this year.

Frankly, I don’t buy this view. Here’s why.

In the short run, look for more downward earnings revisions of the type just issued by TRW. Analysts’ forecasts for the group still call for EPS gains of 10-14% going into next year – a level of performance that looks increasingly unlikely at this point.

As to the long term, the recently announced restructuring moves by Ford and GM are bound to make things tougher, not easier, for their suppliers. Even in the best of times, the market power of the major auto makers has always allowed them to wring price concessions from their parts suppliers. Now that they’re moving towards leaner and meaner business practices, the margins of their suppliers are bound to be affected.

While Ford and GM shareholders have experienced a nice bounce over the last three months, there’s no reason to automatically expect a similar move in the auto parts group.

MGA 1-year chart:

TRW 1-year chart:

JCI 1-year chart:

By Eugene Bukoveczky, Contributor - Investopedia Advisor

At the time of release Eugene Bukoveczky did not own any shares in any of the companies mentioned in this article.

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Tagged: , Auto Parts
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