Slowing U.S. sales of light vehicles are buffeting the auto sector, but the shares of auto suppliers continue to pick up speed.
Some large-cap auto suppliers that have done well year-to-date: BorgWarner (ticker: BWA), up 5.1 percent; Lear Corp. ( LEA), up 6.39 percent; Magna International ( MGA), up 6.5 percent; and Delphi Automotive ( DLPH), up 30 percent, according to Morningstar.
True, most of those names lag the broader market, as the Standard & Poor’s 500 index is up 10.11 percent, but auto suppliers are vastly outperforming automakers. Check out the year-to-date returns of the three biggest auto companies ranked by market share: General Motors Co. ( GM) is up 1.44 percent, Ford Motor Co. ( F) is down 5.69 percent, and Toyota ( TM) is down 8.47 percent, according to Morningstar.
[Read: Why the Auto Industry Is in Trouble (F, GM, TM).]
After several years of record U.S. sales, 2017 may end the winning streak for car companies. In June, J.D. Power and LMC Automotive projected that the seasonally adjusted annualized rate for U.S. retail vehicle sales in the first half of the year would drop 1 percent from last year. So far, LMC Automotive expects total sales of light vehicles — that is, cars, sport utility vehicles and light-duty trucks — to be 17.1 million this year. Although still a solid rate, it would represent a decline of 2.6 percent from last year’s levels.
Patrick O’Hare, chief market analyst at Briefing.com in Chicago, says even though car sales remain historically strong, automakers are being punished because the market and investors believe sales will slide for the rest of the year.
“It’s evident in the monthly sales data that inventory at the auto dealerships are rising. Because of that, there’s an expectation that the auto companies themselves are going to have to increase their use of incentives,” O’Hare says.
The big picture. With U.S. auto sales slowing down, why are the auto suppliers still strong? Market watchers say other factors are at work.
First, most major auto suppliers derive the bulk of their sales from overseas, where car sales are still growing. Kristen Perleberg, senior research analyst and co-portfolio manager at the Leuthold Group in Minneapolis, says the median percentage of sales outside the U.S. for large- and mid-cap auto suppliers is 63 percent.
“It is this diversification across geographies that will act as a buffer if the U.S. auto industry is indeed entering a downturn,” she says.
Large auto suppliers especially have an advantage. “The large ones — the Lears, the Magnas, the Delphis — they have the diversity to grow regionally and make shifts, leverage their niches across supplies, customers and regions,” says Efraim Levy, equity analyst at CFRA in New York.
Major researchers like IHS Markit and LMC Automotive also forecast solid global auto sales. Earlier this year, IHS Markit predicted that 2017 global sales of light vehicles would increase 1.5 percent, much of that from China, and LMC Automotive reported that global sales through May were up 3.4 percent.
If the U.S. dollar continues to weaken, that will support global sellers more, as a weaker dollar makes their goods cheaper, Perleberg says.
Part of the auto suppliers’ firm performance comes from the continued strong auto sales, even if they are off record highs, O’Hare says.
[See: 10 Ways to Invest in Driverless Cars.]
“Over the years, the auto suppliers have figured out ways to cut costs when needed,” he says.
Levy believes the market may be overreacting to slowing U.S. auto sales, and he thinks Ford and GM are being punished unfairly. Not only are these automakers doing better financially because of the restructuring they did several years ago during the financial crisis, but their auto sales also include more light-duty trucks and sport utility vehicles, which are more profitable, he says.
Trucks accounted for 63.7 percent of new vehicle retail sales through June 18, the highest level ever for the month of June and the 12th consecutive month above 60 percent, according to LMC Automotive.
The larger vehicles tend to require more technology and parts per vehicle compared to sedans, Perleberg says. “Higher levels of content per vehicle tend to boost supplier profitability,” she says. “Fortunately for parts suppliers, the trend is currently their friend, as a shift in consumer preference toward larger vehicles continues to grow rapidly.”
Bargains remain. Even though auto supplier stocks have risen so far this year, with some like Delphi up significantly, Perleberg says they still represent a bargain.
“As broad stock market valuations have climbed to elevated levels, this group not only ranks well in value versus other groups, but also looks reasonably priced relative to its own historical valuation levels,” she says.
Most price-to-earnings ratios for the large-cap supplier stocks — like Delphi, Lear, BorgWarner and Magna — trade between 10 and 12 times earnings, she says. That’s less than half of the current S&P P/E ratio of 25.55 times earnings.
Levy rates Lear and Magna a strong buy and Delphi a hold.
As for O’Hare, he says investors haven’t hit auto supplier stocks yet but these companies could face headwinds. He says the average price of new vehicles is around $31,000, putting new cars out of reach for some consumers, especially because income growth has not kept up. That could prompt car sales to stagnate further, eventually hurting suppliers.
[See: 8 Ways President Donald Trump Will Affect Wall Street.]
Although global sales are positive for auto suppliers, Perleberg also cautions investors.
“The Trump administration’s policies and proposed changes surrounding trade do present some uncertainty for this highly globalized group,” she says.
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The Best Way to Invest in the Auto Industry: The Suppliers originally appeared on usnews.com
