Comparing 3 Top Auto Plays That Will Benefit From An Industry Turnaround

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Includes: JCI, MGA, TRW
by: Codespeed

A serious turnaround is underway for the automotive industry in the next two years, giving huge opportunities to investors.

Catalysts For Turnaround

  • A recent report stated that the average vehicle age is 11 years, increased by about 2% compared to 2011's first quarter. This means that in the next few quarters, we should expect increased vehicle demand.
  • Also the loan market for cars and trucks is seeing some strong undercurrents, in spite of the dismal macroeconomic environment. The Fed's rate (currently record low at zero) is the rate at which intra-bank money lending occurs. When interest rates are low, banks get access to money at a cheaper cost, and their lending parameters for customers somewhat loosen.
  • Lately, most banks have allowed customers with weak credit scores to take auto loans. Also, lenders are more prepared to provide longer term loans to make loans more affordable as longer term loans reduce the monthly payment amounts.
  • For consumers, the interest rates for new and used car loans have been lowest since past 4 years.
  • Emerging markets are also growing fast and more people in those countries are beginning to afford vehicles.

All these factors are making a strong case for a major turnaround in the automotive sector.

Don't Go For Car Manufacturers

Car manufacturers for years now have engaged in brand and quality wars against each other that have strongly impacted their operating margins. It could be difficult and probably a bit too aggressive for investors to choose between manufacturers like Honda (HMC), Toyota (TM), Ford (F) or General Motors (GM), to name a few.

Best Auto Parts Companies and Comparison

Instead of car makers, take a look at companies in the auto parts industry, in which there are three major players expected to benefit most from any turnaround: Johnson Controls (JCI), TRW Automotive Holdings (TRW) and Magna International (MGA).

(1) Johnson Controls (JCI)

Johnson Controls is a leading manufacturer of automotive interior systems, batteries and building control systems. Interestingly, not all segments of this company are involved in the automotive industry - Johnson Controls also makes control systems used for energy management in the facilities management business.

(2) TRW Automotive Holding Corps (TRW)

TRW Automotive Holdings Corp. designs and manufactures almost all things related to cars, including steering, foundation brakes, brake control, modules, suspension, air bags, safety components, security systems, body controls, engine valves and various electronic systems for cars.

Catalysts, target price and risks for TRW are discussed in this recent article. The 12 months target price for TRW is above $63, almost 80% gain from it's current price of $35.12.

(3) Magna International

Magna International is a Canada based company that makes a diversified list of auto components and systems. The company's main clients are Ford, General Motors and Chrysler.

Magna announced that it expected to double it sales in China in the next couple of years. The company has a strong balance sheet and it's increased capital spending for 2012 should not pose liquidity issues.

Comparing JCI, TRW and MGA

The comparison of key statistics of these three companies is listed below.

Key Stats JCI TRW MGA
Price $24.51* $35.12* $38.90*
Dividend Yield 2.85% - 2.75%
Market Cap $17.2B $4.4B $9.3B
EBITD Margin (T.T.M) 6.83% 9.85% 6.77%
Operating Margin (T.T.M) 4.98% 7.18% 4.40%
Profit Margin (T.T.M) 4.08% 6.62% 3.56%
Return on Equity (T.T.M) 15.24% 37.55% 12.33%
Return on Investment (T.T.M) 9.79% 24.08% 11.87%
Institutional Holdings 77.90% 94.67% 70.96%
Target Price $39 $63 $54
Click to enlarge

*: Price as of July 23, 2012

Risks

  • The automotive market falls under Consumer Discretionary sector, which is expected to remain under pressure until the consumer confidence increases.
  • Reduced vehicle production due to factor disruptions or economic factors will impact auto parts manufacturers.

Conclusion

In the next two years, the demand for vehicles is expected to rise, albeit slowly in 2012. A rational way to play such a trend is going for the auto parts and equipment companies.

JCI, TRW and MGA have all survived the epic 2009 financial crisis. Amidst chaos and headwinds, these companies have kept their focus on maintaining product lines that are competition-ready for the coming years.

Agreed, there are serious headwinds today, but remember that things do look better than the past two years, and are expected to be much better in the next two.

As of July 2012, all these three companies are rated as Buy or Outperform.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.