American Auto Parts Industry on the Move

Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Auto parts industry overview

The auto parts industry will continue to expand at a steady pace over the upcoming years. With a rising unemployment rate and tight credit markets, new vehicle sales witnessed a declivity of 14% in the previous six years. The growing average vehicle age coupled with the dropping scrappage rate drove the auto parts industry down during the financial contraction, as consumers opted to purchase parts and carry out the repair work themselves instead of buying new vehicles.

Deferred maintenance has been amplifying significantly in dollar terms from $62 million in FY09 to $68 million in FY12, which will further help auto parts companies register proliferating sales in the years to come.

I have opted for a key ratio comparison between the three major operators in the U.S. auto parts industry, which comprises of Wabco Holdings (NYSE: WBC), Magna International Class A (NYSE: MGA) and Johnson Controls (NYSE: JCI).

Comparative analysis

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The auto parts industry grew revenue at a rate of 4.5% in the preceding three years when the U.S. economy was struggling through the economic downturn. However, the selected companies operating in the industry registered a double-digit growth in their top-line with Magna’s revenue growth surpassing its peers, followed by Wabco. Net margin also exhibited the same view, as Magna exercised productivity and efficiency improvements at certain facilities and lower costs were incurred in preparation for upcoming launches.

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Holistically, the key statistics of Wabco are depicting the company to be a cut above the industry and its competitors. To begin with, the operating margin of Wabco is the highest due to the cost management exercised in the area of selling and administrative expenses.

Wabco has been able to outclass its peers and the industry by a large margin in terms of profitability by posting ROE of 42.2%, which is quite higher when matched against its peers and is more than twofold the industry’s average, followed by Magna.

The returns of Wabco and Magna look even more assuring when considering the fact that there is minimal financial risk, as the two companies have not taken on any long term debt whereas Johnson has debt/equity of 0.4, which is lower than industry’s ratio of 0.6.

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The price/earnings to growth (PEG) ratio is used to determine a stock's value while taking the company's earnings growth into consideration, and is regarded to provide a more accurate picture than the P/E ratio. While a low P/E ratio may make a stock look like a good buy, factoring in the company's growth rate to get the stock's PEG ratio can tell a different story.The PEG ratio that indicates an over or underpriced stock varies by industry and by company type, though a broad rule of thumb is that a PEG ratio below one is desirable. As these companies are the fastest growing companies in a sector that I believe will thrive in the near future. Therefore, I have compared their respective PEG ratios. Both Wabco and Magna tend to pose attractive buy opportunities for investors, as exhibited by their PEG ratios, which are less than 1. The lower the PEG ratio, the more the stock may be undervalued given its earnings performance. Buying Johnson to achieve the benefits of its earnings growth rate can be slightly more expensive for investors with its PEG above 1. 

Valuation Based on Comparable Approach

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Multiple based valuation has been used to value each company mentioned in the above table. The valuation metrics, P/E (where P/E represents the price that the investor is paying for getting exposure to one dollar of earnings), P/S (where P/S represents the price that the investor is paying for getting exposure to one dollar of sales) and P/B (where P/B represents the price that the investor is paying for getting exposure to one dollar of book value), are identified for each company and averaged. 

EPS, sales per share and the book value per share of each company have been multiplied with the respective peer averages to come at a fair value of each company, based on each multiple. The product represents the price of the company, justifiable by the representative valuation multiple. The average of these products result in a target value for each company, advocated by the multiples of the peers selected.

As all three multiples were the lowest for Magna, therefore it is the most undervalued stock in the lot. The expected return is calculated as the difference between the fair value calculated and the current market price divided by the current market price.

Compared to the current market price of each stock, Magna and Johnson are undervalued relative to the market while Wabco is relatively overvalued. Based on current market statistics, Magna has a positive potential of 86.85% and Johnson is projected to give a return of 41.02%, while Wabco is projected to report negative returns of 29.45%.

Future prospects

On the grounds of the above analysis, the ascending trend in Magna’s stock price is likely to persist in the upcoming years. With the company’s continuing increase in the production of global light vehicle production in North America and significant growth of sales in the Rest of World segment, the company is expected to post high revenue growth in the future as well. In light of the future growth prospects and the comparable valuation performed, I would advise going long on Magna.

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Awais Iqbal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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