Best Derivative Plays On The Auto Industry

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

In trying to find the best ways to play the upcoming rebound in autos, I have found five stocks that are great ways to diversify beyond your typical Ford or General Motors investment. These include auto parts and components companies, all of which may well provide much better growth opportunities than either Ford or GM. With the average vehicle on the road being over ten years old, the highest in recent history, the pent up demand is there. The demand in the U.S., and globally, has been lagging thanks to a poor economic environment and tight credit over the past couple of years. S&P estimates an increase of 15.4 million units in the U.S. alone for light vehicles in 2013, up from 14.4 million in 2012. The U.S. auto demand should in part drive the global auto industry growth.

Steel is one of the biggest plays on the auto industry and inputs in auto manufacturing. U.S. Steel (NYSE: X) produces and sells steel mill products, including flat-rolled and tubular products. U.S. Steel gets around 70% of its net sales from flat-rolled (involved in auto producing) products. According to the U.S. Steel Industry outlook report, the U.S. comprises over two-thirds of the North American steel production, and the leading consumer of the steel produced will be autos, where the U.S. is the largest steel market segment.

Compared to its industry peers, U.S. Steel appears to be rather cheap on a number of levels:

<table> <tbody> <tr> <td> </td> <td><strong>U.S. Steel</strong></td> <td><strong>ArcelorMittal</strong></td> <td><strong>Steel Dynamics</strong></td> <td><strong>AK Steel</strong></td> </tr> <tr> <td><strong>P/E (next year earnings)</strong></td> <td>14.8</td> <td>20.4</td> <td>12.5</td> <td>33.9</td> </tr> <tr> <td><strong>Price to Sales</strong></td> <td>0.2</td> <td>0.3</td> <td>0.5</td> <td>0.1</td> </tr> <tr> <td><strong>Price to Operating Cash Flow</strong></td> <td>6.0</td> <td>6.8</td> <td>8.6</td> <td>-0.6</td> </tr> </tbody> </table>

Delphi (NYSE: DLPH) and Visteon (NYSE: VC) are two niche market auto parts manufacturers. Delphi is an auto parts supplier, focused on electrical, powertrain, safety and thermal solutions. Visteon operates as an automotive supplier engaged in the design, engineering and manufacturing of innovative climate products. Delphi has a global presence and a strong balance sheet -- with over $1.6 billion in cash and only $2.1 billion in debt.

Placing an auto part makers' average price to earnings multiple (includes Autoliv, Lear and Johnson Controls) of 13.5 on Delphi's next year earnings expectations ($4.25 EPS) and the upside for Delphi is nearly 50%. 

Visteon trades at a trailing price to earnings ratio of 85 times, but only 16 times next year earnings; suggesting investors are not giving enough credit to its expected 65% earnings growth from 2012 to 2013. Visteon has also shown interest in spinning off its interiors business in an effort to focus on the climate segment. Billionaire Steve Cohen is one Visteon's top hedge fund owners (check out all hedge funds owning Visteon). The speculated spin-off would ideally lead to a rise in shares as operations would become more streamlined and valuation more straight forward, where there would be fewer parts of the company to value. Both Delphi and Visteon are somewhat speculative, not being as large and diversfied as the other auto industry players, so buyer be warned. 

Goodyear (NASDAQ: GT) is a leading tire manufacturer, owning about 40% of the U.S. market. The demand for tires should see demand increases with increased auto sales, as well as revenues from tire replacements. The tire company is focused on both top-line (revenue) growth and margin expansion (expense reduction). As far as revenues go, Goodyear has growth opportunities in emerging markets, namely in Asia and of Latin America; as well as new product launches. For expense control, Goodyear has been expanding manufacturing plants in China and Brazil to help with lower production costs. 

Goodyear is also fairly cheap on a price to sales basis when stacked up against other major tire makers: 

<table> <tbody> <tr> <td> </td> <td><strong>Price to Sales</strong></td> </tr> <tr> <td>Goodyear</td> <td>0.16</td> </tr> <tr> <td>Cooper Tire</td> <td>0.37</td> </tr> <tr> <td>Bridgestone</td> <td>0.66</td> </tr> </tbody> </table>

The tire company also appears to be quite the 'growth at a reasonable price' opportunity. The stock trades at a price to earnings ratio of only 8.4 times, and has a 5-year expected earnings growth rate (according to Wall Street analysts) of 44%, putting its PEG (price to earnings-to-growth) at 0.19. Worth noting, Goodyear has no debt maturities until 2014.

Sirius (NASDAQ: SIRI) is a subscription based satellite radio provider that has its radio as the standard product in 70% of the cards produced in the U.S. Fundamental positives for the company are the continued expected growth in net subscribers, expected to add 1.4 million net subscribers in 2013, which would boost total subscribers to over 25 million. While also boosting subscribers, Sirius has been upping its average revenue per user, which was 11% year over year last quarter. The company has managed to grow cash flow from operations 25% cumulatively over the last three years and in an effort to return some of this cash to shareholders Sirius paid a $0.05 dividend to investors near the end of 2012. Sirius also has a $2 billion stock repurchase plan in place. The balance sheet is improving, where the debt to capital ratio for the third quarter was down to 0.35, from 0.79 in the previous year quarter. 

Much like GM, Sirius appears to be a heavily undervalued company and a solid 'growth at a reasonable price' opportunity. The stock is trading at a price to earnings multiple of 6.4, and its long-term expected growth rate (according to Wall Street analysts) is at 27%, putting its PEG ratio at 0.23. 

Don't be fooled. A couple of these stocks are speculative (namely Delphi and Visteon) and depend heavily on the auto industry. Goodyear will undoubtedly benefit from a rebound in auto sales, but will also perform well on maintenance purchases, after all, the average car on the road is over 10 years -- and they all need tires. U.S. Steel has solid exposure to the auto market, but also has other segments, including tubular -- inherent exposure to oil, which helps diversify its operations. Sirius is a solid cash flow generator that may continue to reward shareholders. 

mhargra 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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