Novice Investing - Diassembling Auto Part Suppliers

Date: Sunday 20th 2008f July 2008 12:45:57 PM

Disassembling Auto part suppliers - 04/05/2005

By: Hari Wibowo

In the beginning, there is General Motor...

It starts with a warning. General Motors Corporation (GM) announced a massive shortfall of profit for the quarter. The stock sank to less than $30/share. In the meantime, GM's supplier dropped on the news too. Are they in trouble too? You bet. However, GM is not their only customers. Therefore, in this column, I am trying to dissect those auto suppliers that have less dependence on GM and Ford (which I suspect will be announcing a production cut too).

High oil and component price such as steel has reduced profitability of these companies. I am not sure how high steel price can go but I do think that the trend will not last forever. Just a few years back, President Bush was trying to impose steel tariff to foreign competitors due to their entry into the United States. Now, high steel price squeezes the profit of these auto suppliers. I still believe steel industry is a commodity which will experience boom and bust. When the bust happens, you can expect excess capacity as companies are willing to shut down an entire plant because of the high fix cost.

So now, after giving you reasons to consider looking at these auto suppliers, let's move on to the list. Here it is:

Company	Market Cap	Recent Sales composition	Projected Earning per Share	Net Cash/ Share	Fair Value	Recent Price	% Return
Johnson Controls Inc.	$10.57 B	14%F, 14%GM, 10% DCX	$ 4.57	($7.47)	$65.6	$55.30	18.6%
Magna International Inc.	$ 6.96 B	16%F, 22%GM,23%DCX, 20%BMW,8% VW	$ 7.46	$7.19	$126.55	$66.60	90.1%
Autoliv Inc.	$ 4.30 B	23%F, 12%GM, 15% Nissan, 7%DCX, 7% Toyota	$3.72	($4.77)	$54.75	$46.82	16.9%
Lear Corp	$ 2.96 B	31%GM,24%F,12%DCX	$3.86	($19.1)	$42.66	$44.16	(3.4%)
Delphi Corp	$ 2.42 B	40% GM	($0.71)	($3.15)	N/A	$ 4.32	N/A
Dana Corp.	$ 1.88 B	25%F, 11%GM	$1.17	($9.59)	9.13	$12.52	(27.07%)
Clarcor Inc.	$1.35 B	No single customer above 10% of sales.	$2.69	$0	$46.4	$52.34	(11.3%)
American Axle & Manufacturings Holdings	$1.21 B	80% GM	$2.05	($8.80)	$24	$24.26	(1.05%)
ArvinMeritor Inc.	$1.08 B	13%GM, 10%F,10%VW	$1.59	($20.5)	$4.94	$15.36	(67.8%)
Visteon Corporation	$ 732 M	76% F	($0.54)	($5.83)	N/A	$5.69	N/A
Superior Industrial Intl	$ 691 M	36%F, 43%GM	$1.33	$4.50	$23.12	$25.98	(11%)
Noble International Ltd	$ 203 M	34%DCX, 24%GM, 29%F	$1.57	($2.26)	$19.72	$ 21.83	(9.6%)
Torvec Inc.	$ 115 M		N/A	$0.03	N/A	$ 4.00	N/A
Dura Automotive Systems Inc.	$ 92.02 M	20%F,14%GM,12%Lear, 9% DCX	$0.30	($53.5)	($49.3)	$ 4.93	(100%)

Wow. That is a long list, isn't it? It sure does. Relax. I will summarize what the table means here. Basically, we are trying to predict the fair value of these companies by using rate of return of 6.25% (P/E of 16) for companies with market cap above $1 Billion and rate of return of 7.14% (P/E of 14) for companies with market cap lower than $1 B. Hey, don't worry. If you need to review our fair value calculation, click here.

As you can see, auto suppliers range from $10.57 Billion of market cap to below $100 Million. To be fair, the larger auto suppliers are a safer play compared to the smaller ones. Therefore, I would put a fair value calculation at a P/E of 16 for companies with market capitalization of above $1 Billion and P/E of 13.5 for companies with market capitalization of below $1 Billion.

A P/E of 16 sounds too aggressive considering it only gives us a yield of 6.25%. However, remember that these companies are at the bottom of their cyclical cycle. Steel prices are squeezing their margin while automakers are starting to cut production. There is of course no guarantee that the earning estimate will stop coming down but it is a reasonable guess.

Right now, let us just cross out companies that are not expected to make money this year. The reason is that the list contains companies incurring a negative net cash; meaning they have more long term debt than cash on hand. It is safer to invest in companies with lower leverage and higher profits. Therefore, for leveraged balance sheet such as this sector, I prefer to invest in the companies that are profitable.

Furthermore, we will avoid companies that have a fair value of less than the current price. So now, the list is shortened into three companies: Johnson Controls Inc. (JCI), Magna International Inc.(MGA) and Autoliv Inc. (ALV). Accidentally, these three companies are the biggest in the sectors. Dissecting further, Johnson Controls has 38% revenue stream from the big three US automakers (General Motor, Ford and Daimler Chrysler), 61% for Magna International and 42% for Autoliv Inc. It is my believe that Japanese competitors slowly eat away the big three's market share domestically, therefore becoming too reliant on these three automakers are not a good sign.

Out of these three auto suppliers, I am favoring Magna International (MGA) because of the positive net cash balance (more cash than long term debt) and higher fair value. I realize that MGA has more reliance to the big three automakers than the other two, however given the potential return for MGA (90.1%), it is worth it to take a closer look. I will analyze company more and hopefully I would put MGA into our sample portfolio once I have done my analysis.

As investors, I think only these three companies are safer than the rest because of their size, fair value and solid balance sheet. As always, taking more risk normally gives you more return but I tend to lean on the safe side when investing.

END

[Resources] [Forum] [Link Partner ] [Novice Investing Directory ] [ Submit Your Article Here ]