Overdrive for auto parts makers?

Federal Mogul's aftermarket spin-off is a green light for the sector.

By InvestorPlace Mar 19, 2012 10:12AM

By Susan J. Aluise

 

Two conflicting trends -- white-hot new auto sales and the increasing age of vehicles on the road -- are combining to create a sweet spot for auto parts manufacturers. And companies that straddle the original equipment (OE) and aftermarket businesses have the opportunity to cash in big at both ends of the auto parts lifecycle.

 

Auto parts imports rose 10.4% in January to $25.3 billion, according to Commerce Department data released last week. But U.S. auto and auto parts exports also rose during the month, hitting a record $12.7 billion.

 

Auto parts demand is linked to new vehicle manufacturing because about 70% of production is for OE parts; the remainder is for the aftermarket. U.S. new-car sales blew the doors off analysts' expectations in February, hitting a seasonally adjusted annualized rate of 15.1 million. If that trend holds throughout the year, automakers will be well on their way to restoring sales to pre-recession levels.

 

The new sales data are even more significant given the fact that new-car sales hit only 11.8 million last year. Just days earlier, JD Power & Associates raised its sales forecast from 13.8 million to 14 million for this year. This is a clear signal that the industry finally is beginning to see the long-hoped-for "pent-up demand" translate into new replacement vehicles.

 

But that's only half of the story. Despite the boom in new vehicle sales, the average vehicle on the road continues to grow older, now at an average 10.8 years old, according to the research firm R.L. Polk.

 

Polk researchers discovered two related trends: New-car buyers are keeping their vehicles for nearly six years, while those who bought used vehicles are keeping them for more than four years. Those record numbers illustrate that consumers are still skittish about high unemployment and a weak job market. And the older a vehicle gets, the more likely it is to require replacement parts.

 

That puts auto parts suppliers like Johnson Controls (JCI), BorgWarner (BWA), Delphi (DLPH) and Tenneco (TEN) with exposures to both the OE and aftermarket sectors in the catbird seat.

 

Investors can find opportunities in both sub-markets. Consider Carl Ichan's Federal Mogul (FDML), which last week announced it would spin off its $2.3 billion aftermarket business into an independent division. The move comes as CEO Jose Maria Alapont is retiring. Rainer Jueckstock, senior vice president of FDML's profitable powertrain energy unit will take over as CEO on April 1. The company has initiated a search for a CEO of the new aftermarket business.

 

FDML's OE business -- which sells parts to automakers -- grew by a whopping 18% last year. The most robust growth -- 26% higher sales than in 2010 -- came in the so-called BRIC markets: Brazil, Russia, India and China.

 

The company's aftermarket business suffered fourth-quarter sales declines in the U.S., but 6% growth in Europe and strong double-digit growth in the BRIC markets. On average, FDML's global aftermarket sales remain stable, and spinning off the aftermarket business into a separate entity could sharpen its focus and boost sales.

 

The companies that straddle both segments of this market have learned the hard lessons of the recession and are leaner and meaner today than they were four years ago. The key to success for these companies will be on crafting tight -- and reliable -- relationships with automakers.

 

The parts shortage stemming from Japan's earthquake and tsunami disaster a year ago shook automakers' "just-in-time" supply-chain models to their core. Now, the car companies need their suppliers to have global reach, innovative technology and trusted integration with manufacturing processes.

 

Bottom Line: Because pent-up demand finally is beginning to drive consumers to the dealership, car sales could be pedal to the metal in 2012 -- and that bodes well for strong growth in OE parts. But lots of old cars are still on the road, and that's an ongoing opportunity for aftermarket sales.

 

In this sector, I particularly like companies with a strong edge in innovative technology like JCI, which has hybrid electric and plug-in hybrid vehicle power products, or Tenneco in emissions control systems. Companies with a lot of cash like Delphi and BorgWarner are in a little better position if the economy turns south, or if commodity prices rise unexpectedly.

 

As of this writing, Susan J. Aluise did not hold a position in any stocks mentioned here.

 

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