In my ’22 outlook piece, I said I am bullish on auto supplier stocks:
When do you have recession levels of production, but demand has already improved drastically? Even if demand slows, production has to be elevated to restock the channel.
Investors are always worried about demand and production levels in autos given high fixed costs, but the visibility of go-forward production levels is obvious: UP!
I want to lay that thesis out a bit more and highlight a basket idea I have. I already have American Axle and Strattec in my recs, but I am adding Magna International, Lear and Ingevity to the mix. I discuss others below as well.
Let me also state I know auto supplier stocks are value traps – they trade at low multiples for a REASON. Many reasons. But let’s lay out the bull case.
Why am I so confidant in auto restocking?
First, here is annual SAAR, or the number of units sold each year. We typically ran 15-17.5MM units in the US:
Domestic production is running at just 12.5mm units. Here’s inventories, in units
And here is inventory to sales ratio. Normally I don’t prefer this, because a 1x elevated pace can make it look bullish at the top of the cycle. But that isn’t what happened here.
It is no wonder why used car prices have surged – we are short cars. As I put in my prior posts, many dealers I follow have less that 25 days of inventory on hand compared to 60+ days pre-COVID.
With no production issues in 2022, I think it likely takes until 2023 for passenger and truck inventories to normalize.
Here are some comments on that:
So I think what you’ll find is that, as you look through 2022, the first half, we’ll have less supply than through the second half. And as I said earlier, we see this mitigating over time. It may extend into 2023. But I would say that we should be back up and running based on what we’re seeing today, a run rate, the end of next year into ’23. And then in 2023, we’d start to rebuild our inventories.
-John Lawler, CFO of Ford
As we indicated, we see a very bright future and a very strong demand for the various platforms that we support for years to come, especially because of where the inventory levels are and because of the consumer demand that exists in the marketplace. And as I said, as fast as the OEMs can build them, the consumers are buying them.
So I think it’s going to take an extended period of time to rebuild the inventory levels. That’s going to put us in a very healthy position to generate a lot of cash for our business. We’ll use that cash as we always have to continue to support our organic growth, a big shift in our organic growth is towards electrification.
We think it will take a minimum of 24 months to replenish the value chain. And therefore, we see some bright days ahead of us as it relates to our ability to generate cash, pay down debt and fund our electrification growth in the future.
–David Dauch., CEO of American Axle
I think if you look at ’21 versus ’22… the biggest impact on decrementals/incrementals is really the start-stop and the inefficiencies that we have in our facilities. And I expect that’s going to go away as we work through ’22. And that’s the biggest item order of magnitude against some of the inflationary pressures are — will have — I expect will have an impact.
-Vince Galifi, Magna International CFO
What are the best plays?
I may not know the best plays, but this is what I am doing. I’ve already written up $AXL and $STRT and those are my top ideas for this.
Here are some other thoughts. Note, a lot of my estimates tend to be higher than consensus, because sell side tends to stink at modeling fixed-cost absorption. I should also say I am looking for cheap names I don’t think will underperform for some other reason (e.g. EV risk) and that’s why I exclude a Garret Motion or a BorgWarner – I just want exposure to my thesis. I do like those too and full disclosure am long the GTX prefs in my PA.
- Magna International ($MGNA) should benefit from increased production plus. Valuation is undemanding at ~5.5x 2023 EBITDA. This is generally a “safe” auto supplier name as they have less exposure to “EV risk”, in that some suppliers products may be disrupted. MGNA is “drivetrain agnostic” as they say, but also pretty diversified across exterior parts, drivetrains, seats, etc. There was this report stating Magna was involved in the powertrain for an Apple car. Who knows, but MGNA really does have its hand in a lot of EV related things, but also is generally tied to auto production.
- Lear ($LEA): Lear is dominant in seats (Lear and Adient each control about 22% of the market, followed by Magna at 7%, and then other small players). Lear doesn’t really have EV risk in my view with seats. They are also a leader in wiring components. With EVs and ICEs having higher electrical content per vehicle, Lear is a long-term winner. I do think the street may be underestimating Lear’s profitability when it is running flat out, though if I am wrong, Lear’s upside is admittedly capped. But assume 10% EBITDA margins on ’22 consensus sales, it trades for ~5.75x EBITDA. Lear last earned these margins back in 2013-2014 when they were running really strong. Lear used to buyback a lot of stock – back in 2013, they bought back $1bn, or 16% of shares. I love it when companies buy back huge slugs of stock at one time
- Adient ($ADNT): A possible play, but turnaround story (former spin from Johnson Controls, margins well below Lear). I think I am a pass here, but bring it up for those who want the highest beta. The hardest part is they generate basically no FCF. If you buy the turnaround story (mgmt says 500bps of margin improvement was disguised by inflation in ’21) it could make a lot of sense. An improving ROIC + Growth = winner stock. And their growth is near 1:1 with production.
I know, I know – there are a ton of suppliers and so I don’t have to cover them all. Here are some other tertiary ideas, though:
- Cars.com et al ($CARS): With tight inventories, dealers and OEMs have been able to cut incentives as well as advertising. When inventories normalize, so should incentives and ads. Up to you on this one. Cars.com does look optically cheap, but I don’t know it well enough.
- Ingevity ($NGVT): Under-discussed name and likely requires its own post as it is a fascinating business. This is a chemical business attached to an auto-component business. A former spin-out of Westrock, the chemical business uses pine-based chemicals to make certain resins used in paving, inks, O&G, etc. The auto component is basically a vapor control system in cars that utilizes activated carbon. While I said “no EV risk,” this truly is a great business as they essentially have a monopoly on the business (and it has 56% EBITDA margins in good times! Alas – because of lower auto production, Q3 margins were down >800bps. Guess what happens when that reverses?). >10% fwd FCF yield is too cheap.