Auto Equipment Outlook: Cost & Technology Bumps Ahead

The Zacks Automotive - Original Equipment industry includes companies that engage in the designing, manufacture and distribution of automotive equipment components used for manufacturing vehicles. A few of the components manufactured by the participants include drive axle, engine, gearbox parts, steering and suspension and brakes.

Some prominent players within the industry are BorgWarner Inc (NYSE:BWA). (BWA), Adient (ADNT), WABCO Holdings (WBC) and Continental AG (DE:CONG) (CTTAY).

Let’s take a look at the industry’s three major themes:

• Emerging economies such as China, India and Brazil as well as the nascent markets of Asia, Middle East and Africa offer huge growth opportunities for equipment manufacturers. Of late, industry players are collaborating with local entities in emerging markets to be on par with region-specific technological developments without heavy investments.

• With the technology shift in full swing, equipment manufacturers have to develop components that comply with emission standards, and meet the critical requirements of electric and self-driving vehicles. These new features, upgrades and component designs require abundant capital, time and labor.

• The introduction of new technologies like automation, digitization and artificial intelligence has added to the complexity in the working mechanism of automotive components. These complications call for high-priced aftersales services, thereby creating new opportunities for auto equipment manufacturers to capitalize on.

Zacks Industry Rank Shows Weak Prospects

The Zacks Automotive - Original Equipment industry is a 41-stock group within the broader Zacks Auto sector. The industry currently carries a Zacks Industry Rank #211, which places it in the bottom 17% of approximately more than 250 Zacks industries. The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Over the past year, the industry’s earnings estimate for the current year has moved down 25.6%.

Despite the industry’s bleak near-term view, we will present a few auto original equipment stocks that one can consider. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Lags Sector & S&P 500

Over the past year, the Zacks Original Equipment industry has lagged the broader Auto sector as well as the Zacks S&P 500 composite. The industry has declined 18.1% over this period compared with the S&P 500’s rise of 1.3% and broader sector’s fall of 14%.

Industry’s Current Valuation

On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA), which is a commonly used multiple for valuing auto stocks, the industry is currently trading at 6.54X, lower than the S&P 500’s 10.7X. Additionally, the industry’s figure is below the sector’s trailing-12-month EV/EBITDA of 9.44X.

Over the past five years, the industry has traded as high as 11.14X, as low as 4.63X and at a median of 6.81X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

Bottom Line

The industry’s success depends on how well the players manage escalating costs incurred on mass manufacturing and evolving technology. Also, the ability of the industry to comply with the new emission norms is a challenge. However, growing demand from the emerging economies is a tailwind.

Some top-ranked stocks in the Zacks Original Equipment space are Allison Transmission Holdings, Inc. (ALSN), Meritor, Inc. (MTOR) and Gentex Corporation (GNTX), each of which currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Allison Transmission: This Indianapolis, IN-based company is a designer and manufacturer of fully automatic transmissions for medium and heavy-duty commercial, and heavy-tactical U.S. defense vehicles. The Zacks Consensus Estimate for the current-year EPS of this company has moved 4.1% north over the past 30 days.

Price and Consensus: ALSN

Meritor: The consensus EPS estimate for this Troy, MI-based global automotive parts manufacturer and supplier has increased 5.1% over the past 30 days.

Price and Consensus: MTOR
Gentex: The consensus EPS estimate for this Zeeland, MI-based supplier of automatic-dimming rearview mirrors and electronics has increased 2.4% over the past 30 days.

Price and Consensus: GNTX

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