3 Stocks to Rev Your Portfolio in 2013

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

Investors looking to rev up their portfolios in 2013 should strongly consider adding exposure to the auto part manufacturers.  This sub-industry was on many buy lists heading into 2012 due to strong improvement in auto sales following the depths of the Global Financial Crisis.  These recommendations were likely a year early and 2013 is poised to be the breakout year. 

The Russell 1000 Auto Parts Index finished 2012 with a total return of 14.8% versus 16% for the S&P 500.  But it was a tale of two halves.  Through the first seven months of the year, the auto suppliers trailed the S&P 500 by a resounding 16%!  In the final five months they soared 22% against a modest 4% advance for the S&P 500.  This relative performance gap is in its early innings and substantial upside still lies ahead thanks to robust fundamentals and attractive relative valuation.  Below are three reasons why auto part manufacturers will outperform in 2013 and a couple accompanying investment recommendations.

Pent-up Demand

U.S. light vehicle sales increased at an annual rate of 15.3 million in December.  This continues a clear uptrend that has persisted since sales collapsed during the financial crisis to fewer than 10 million.

<img src="/media/images/user_36/us-autos_large.png" />

Despite this sharp advance, there is still substantial pent-up demand.  As seen in the chart, annual auto sales were running in the 16 million-18 million ranges prior to the financial crisis.  Sales now reside below that level despite the fact that the U.S. population has advanced by 25 million people in the last decade!  Throw in the fact that the average age of autos in operation is now more than 11 years versus 9 years a decade ago and there are plenty of reasons to believe that auto sales should again peak out near 18 million during non-recessionary periods.  Oh yeah, and this isn’t even the growth story.  Emerging markets is where the growth really lies in the next 5-10 years on top of mean reversion in developed regions.

Johnson Controls (NYSE: JCI) is the big fish in the relatively small pool of names.  The company generates annual sales in excess of $40 billion and is the clear industry leader in automotive seating.  While this segment accounts for the majority of sales, the company derives plenty of profit from other things such as instrument panel and infotainment electronics, door panels, and battery solutions.  The company has made China an investment priority and should be a clear benefactor to economic growth in the region.  For those that favor dividends, the company has a consecutive payout streak that dates all the way back to 1887!  The current yield is 2.4%.

Historic Low Interest Rates

Historically low interest rates have made new car purchases more affordable than ever.  The chart below shows the number of weeks of median income needed to purchase a new car.  Despite stagnant incomes, low interest rates have pushed car affordability to near-record levels.  This, combined with pent-up demand, is a clear recipe for outperformance.

 

<img src="/media/images/user_36/auto-afford_large.png" />

BorgWarner (NYSE: BWA) is the industry leader in engine and drivetrain solutions.  The company has plenty of favorable attributes that should help fuel a rising stock price.  First, they sell to nearly every original equipment manufacturer with Volkswagen the only customer accounting for more than 10% of total sales.  The company has a strong track record of generating mid-teen returns on invested capital.  BorgWarner stands to produce strong secular earnings growth as regulations require ever improving fuel efficiency standards.  The stock has been flat the last two years, but earnings-per-share grew from $3.02 in 2011 to $4.45 in 2012.  Double-digit growth is anticipated going forward and the current P/E multiple of 16x may be underestimating the operating leverage and potential for big earnings upside.

Rock Bottom European Expectations

Many of these auto parts suppliers have heavy exposure to Europe and this was likely the biggest headwind to performance in early 2012.  BorgWarner derives 56% of sales from Europe and nearly every global auto part supplier will have significant exposure to the region.  It likely isn’t a coincidence that the EURO STOXX 50 Index advanced 14% in the final five months of 2012 as the auto part companies were zooming to a 22% advance.  The more cyclical stocks in Europe showed gains of 20%-50% off summer lows.  Clearly stated, European expectations are at rock-bottom levels and just the mere presence of stability in 2013 should pave the way for better than expected results. 

One of the better secular growth prospects with high exposure to Europe is Harman International (NYSE: HAR).  Europe is more than 60% of sales as infotainment devices have made great inroads into luxury German automobiles.  Infotainment accounts for more than 50% of Harman’s sales and has strong secular growth prospects with industry-wide penetration at just over 20% in developed countries.  Experts believe infotainment devices will eventually accompany 50% of new car purchases in such regions.  The company has streamlined itself and removed more than $400 million of costs since 2008.  Harman International reported a 41% increase in 2012 adjusted EPS to $2.93.  The company forecasts continued mid-teens sales growth, which makes the current trailing price-to-earnings ratio of 16x a compelling GARP opportunity.  

The Foolish Bottom Line

Auto part supplies are poised for a big year in 2013.  The aforementioned names all have leading market share positions in secular growth industries.  Automotive affordability is likely to remain exceptionally low with the Federal Reserve’s commitment to leaving rates unchanged until unemployment drops below 6.5%.  It was 7.8% in December.  If Europe shows just a little pulse, let alone a combined surge from both China and Europe, then sales and earnings expectations should see strong increases as the year progresses.  This should propel auto parts stocks to the front of pack in 2013.


market8 has no position in any stocks mentioned. The Motley Fool recommends BorgWarner. 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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