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Why You Should Invest in This Auto Parts Supplier

October 17, 2013 | About:
Pato Kehoe

Patricio Kehoe

7 followers
Automobile manufacturers have been performing well as of late, largely due to increasing sales pushed by a recovering U.S. economy and growing emerging markets. Auto parts suppliers, such as TRW Automotive Holdings Corp (TRW) and Johnson Controls Inc. (JCI), are bound to benefit largely from rising sales, and thus present themselves as interesting investment opportunities. However, due to their focus on different industry segments, and their current stock valuation, investing in only one of these companies makes sense.



Safety Sells


With over 180 facilities in 26 countries, TRW Automotive caters active and passive safety systems to every major automaker in the world. The company is well diversified, producing braking, steering, and electronic components, modules, and systems. Although the firm had an outstanding amount of debt just some years ago, it has been recovering spectacularly, reducing debt levels by half since 2007. John Hussman of Hussman Economtrics Advisors is a TRW Automotive bull, with a 500,000 share stake in the firm.

Economic profits have been generated consistently over the past years, making the auto parts supplier a reliable investment. The largest array of safety products available, a global manufacturing footprint, and a diversified customer base are some of the key factors behind TRW Automotive’s success. Also, enduring customer relationships, facilitated by the high customer switching costs, have allowed the firm to increase sales continuously. As government regulations related to automobile safety increase globally, the company is well positioned to follow its current upwards trend.

The firm’s ability to produce innovative technology, in the passenger safety and engine fuel efficiency segments, is largely responsible for its recent success. Despite limited cash and high debt levels in 2007, the company was able to push its restructuring efforts forward, showing strong signs of operational improvement.

Looking forward, TRW Automotive is well positioned to continue growing. The automobile industry is in full recovery in the U.S., and growing rapidly in emerging markets. Since the company deals with every major automaker in the world, it can gather profits from increasing auto sales in any geographic location. Also, the stock is currently trading at 9.7 times its trailing earnings, which translates to a 38% price discount to the industry average. At these values, TRW Automotive is surely worth buying, especially due to the positive outlook it is facing. With the backing of John Hussman and improving financials, I feel very bullish about this stock.

An Expensive, But Diversified Supplier

As a manufacturer of control equipment, car interiors, and batteries, Johnson Controls has become a leading supplier for the automobile industry. The firm is divided into three segments: building efficiency, automotive experience, and power solutions. These three groups form a $42 billion business, which has been underperforming in recent years but is set to improve in the near future. Investment gurus Scott Black of Delphi Management and John Burbank of Passport Capital think so, as they recently increased their stake in the firm.

As a leading supplier of automobile seating and interior, Johnson Controls enjoys a favorable position in the industry. However, cyclical declines in sales have motivated the firm to seek further diversification. As a result, the battery and control equipment segments now contribute 49% to sales, making the firm less reliant on a single product sector for revenue. The battery business is especially important, since new hybrids are generating high levels of demand for Johnson Controls’ batteries. In addition, the acquisition of the Delphi global battery business, gave the company a stronger position in this industry segment. As the Asian battery market continues to thrive, the company is set to participate in the growing industry, making large profits. Looking forward, Johnson Controls anticipates benefits to arise from its focus on China. With 26 manufacturing plants in this thriving country, dedicated to the seating business, the firm has already captured 50% of market share.

Although Johnson Controls’ financials are not as strong as I would like them to be, improvement is underway. Cash flow has been increasing steadily and the firm is expecting an even better performance during the second half of the year. However, the stock is currently trading at 26.3 times its trailing earnings, representing a whopping 68.5% price premium relative to the industry average. Hence, although I feel bullish regarding the company’s future, the time for entry has passed.

Entry Point Is the Key

Both TRW Automotive and Johnson Controls are firms with a bright outlook. Despite putting their focus on different industry segments, both companies have large customer bases and are highly diversified. However, only TRW Automotive is currently trading at values that make entry not only reasonable, but also a wise investment option. In addition, the company has a strong financial position, with large free cash volumes and steadily declining debt, whereas Johnson Controls does not have the cleanest balance sheet. When looking to invest in the auto parts industry, I recommend TRW Automotive.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.0/5 (5 votes)

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