Auto Resurgence in High Gear

 | Sep 30, 2013 | 4:00 PM EDT  | Comments
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One of the strongest comebacks in this U.S. economic recovery has been in the auto industry.

 After light vehicle sales in the U.S. peaked at 17 million units in 2005, auto sales fell by over 40% to 10.5 million units in 2009. By the end of 2012, unit volume had climbed back up to 14.4 million, and the run rate in 2013 suggests total unit volume that could reach 16 million. Over the next several years, U.S. auto sales should continue to show respectable growth.  

That's because the recession forced many people to hold on to their vehicles a lot longer than is typical in the U.S. They simply could not afford to trade in the clunker and upgrade. For others, it was the freezing of the credit markets that made financing a car that much more difficult. Both of those circumstances have eased significantly, especially vehicle financing. Anyone looking to buy a new car or nearly new vehicle will find financing rates extremely low, in many cases zero percent for 48-to-60 months.  

I'm very favorable to General Motors (GM) as the pure play to capitalize on this continued trend. GM is still somewhat viewed as Government Motors, but Uncle Sam is readily selling his equity stake. Once that overhang vanishes, investors will notice, at a market cap of $50 billion compared with Ford (F) at $67 billion, how attractive GM's valuation is.

Yet the auto industry is massive and its resurgence spells opportunity for many other businesses that benefit from new vehicle demand. Small-cap Superior Industries (SUP), a maker of steel and aluminum wheels, is one. Debt free with a market cap of $500 million, Superior boasts a 4% dividend yield to boot. A new plant in Mexico that is due to come on line by 2015 will increase wheel capacity by some 15 percent.

Over 50 percent of Superior's business goes to Ford and GM, so they will ride on the coattails of those top car makers. As the plant in Mexico starts producing, the company's cost structure should improve and margins should grow. Shares currently trade for $17.80, near a 52-week low. Patient investors will appreciate the total return offered by this name over the coming years.

Goodyear Tire (GT) is another interesting idea at the current juncture. With a market cap of $5.5 billion and an enterprise value of $9.5 billion, Goodyear's $5 billion in total debt is more than covered by $1 billion in annual operating cash flow produced. While current capital expenditures are absorbing most this cash flow, continued cost savings are likely to fuel earnings in the coming years. Indeed, current estimates of 2013 earnings per share of $2.35 may prove to be conservative. In any event, earnings beyond 2013 are expected to climb at a healthy clip. 

Standard Motor Products (SMP) is another small cap supplier of engine and temperature control parts to the automotive industry. At $32 a share, or 16x trailing earnings, the company's valuation is quite reasonable especially from a cash flow perspective. Free cash flow last has been growing mightily over the past three years and last's tally of $80 million compares with an enterprise value of $800 million. While sales growth slowed down in the second quarter, profitability improved thanks to increasing operating margins. These stronger margins should aid profit growth if sales stall in the coming quarters. That being said, over the next couple of years sales should pick up as demand from original equipment manufacturers picks up.  

Any hiccup in the stock market in the coming days or weeks will likely affect these stocks. Folks buy cars when they feel confident, and at the moment the political headlines aren't doing a great job of inspiring confidence. But these are quality companies that would become even more attractive in the event that volatility creates better prices.

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