Salvaging for Auto Parts Investment Bargains

S&P expects the subindustry to remain lackluster, though some improvement may be just around the bend

While wandering through the relative strength charts for the more than 120 subindustry indexes, I came across this rolling 12-month relative price performance chart (pictured ) for the S&P 1500 Auto Parts index. To be sure, there's been plenty of bad news of late for the group, including the bankruptcy filing by Dana Corp. in early March. But the chart indicates to me that the relative beating that this group has taken appears to have subsided.

As a reminder, the jagged blue line represents the sub-industry index's rolling 52-week price performance compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindex's 14-year mean relative strength.

So, of course, my first thought was, "Is it time to buy back into these issues?" I decided to check with Efraim Levy, CFA, S&P's Autos and Auto Parts analyst. In essence, he suggested I continue to let them rust.

S&P's fundamental outlook for domestic auto parts manufacturers is negative. The S&P Auto Parts & Equipment index underperformed the S&P 1500 index in 2005 with a 21.5% decline, vs. a 3.8% rise. Year to date through Mar. 3, the subindex was down an additional 10.8%, vs. a 3.6% increase for the S&P 1500.


  Levy thinks the group will be hampered by price pressure from manufacturers and higher commodity prices. New products coming from General Motors (GM: sell, $22) and others, and an easing of steel prices should help in 2006, in S&P's view. However, the bankruptcies of Dana and Delphi could put further pressure on parts suppliers.

S&P's outlook for 2006 original equipment sales is modestly negative. Levy sees light vehicle sales volume of about 16.7 million in 2006, down from the nearly 17 million units in 2005. He expects the Big Three to collectively lose share to foreign brands. The greater a supplier's exposure to these domestic companies, in S&P's opinion, the greater the impact.

Levy sees flat to lower European car production in 2006, although production trends should vary by country, which is likely to affect parts manufacturers with European exposure. He projects higher production in Asia, led by China. S&P expects the U.S. automotive parts replacement market to remain lackluster, although Levy thinks demand for new commercial (heavy) trucks will rise again, albeit with more modest increases. Auto makers' demands for price reductions may weigh on suppliers. The analyst believes that rising automobile production in Asia is an opportunity for larger, multinational suppliers to increase sales and profits.


  For the longer term, Levy expects growth opportunities for original equipment manufacturers (OEM) to arise from several sources. First, he sees a rush to add high-tech features to vehicles to distinguish them and to comply with safety and emission regulations. Second, in S&P's view, global expansion is aiding those parts producers that are structuring their businesses to support auto makers' efforts to consolidate designs across their international operations and expand their international businesses. Third, Levy sees an increase in business arising from foreign carmakers setting up production in the U.S.

So there you have it. Maybe the worst is over for this group from a momentum standpoint, and even though the group could experience some unexpected short-term revving-up of share prices, S&P believes the investment outlook for the S&P Auto Parts group is decidedly negative over the coming 12 months. None of the stocks in the group carry S&P's top investment rankings of 4 STARS (buy) or 5 STARS (strong buy). Lear Corp. (LEA), Arvin Meritor (ARM), Borg Warner (BWA), and Visteon (VC) are among a number of companies ranked 3 STARS (hold).

Source: Standard & Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Mar. 3, 2006.

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