This commentary originally appeared on Real Money Pro at 08:00 on Jan. 22, 2016. Click here to learn about this dynamic market information service for active traders.
The slowdown in China has driven several high-quality auto and industrial parts suppliers to multi-year lows not seen since the last recession. Over the past year, Borg-Warner (BWA) has declined 47% from its peak, Johnson Controls (JCI) -38% and TE Connectivity (TEL) -25%. Most of the decline is due to slowing auto parts demand from China, as sales in that country went negative.
Nevertheless, at these current price levels we believe that the worse is being baked into the shares and we would use the bear market in the group to begin or add to positions here.
We believe the most attractive name in the group to own is Johnson Controls. Chinese auto sales are weighing down results. However, what many fail to understand is that the majority of the earnings are generated from its Building Controls and Power Systems businesses (automobile batteries), which are not related to the new car auto cycle. Furthermore, both of these units continue to see positive top and bottom line growth.
The Auto business is acting as a drag, but it is more than being offset by the other parts of the company. At a recent price of $34.36, the shares were trading at an attractive 9.1x 2016's EPS estimate of $3.78. The shares typically trade for 12 to 13x earnings.
By the fall of 2016, JCI will also spin off its auto parts unit to shareholders, and many expect the overall valuation level of the company to improve following that move. There is no reason for the stock not to get back over $50 per share, as business conditions eventually improve.
TE Connectivity is our next pick in the group. The company focuses on providing electronic components (connectivity and sensor solutions) to most industries in the increasingly wirelessly connected world. Business has slowed in the past year around the auto and industrial units, in particular relating to China. However, the company reported better-than-expected results this week as the broader global auto demand was steady in the quarter, while aggressive cost-cutting programs added to results.
Furthermore, management expects Chinese auto demand to improve through the year, after inventories have been destocked and the Chinese government announced new tax programs to encourage auto purchases. On the company's earnings callm, they noted that business in China this past quarter was better than expected.
Beyond any short-term issues, we believe the massive increase in connectivity and smart cars and devices leaves TEL at the forefront of a wave of increased electronic connectors and sensors. The tremendous increase in technology in automobiles, including safety features like lane-keeping assist, blind spot information or adaptive cruise control are all built on TEL-type products.
The tone of the call was very positive, and TE Connectivity reaffirmed its guidance for 2016. The shares are attractively valued at a little over 14x 2016's EPS estimate of $3.95. The shares typically trade for over 16x earnings.
Lastly, Borg-Warner is also very attractively priced at about 9x 2016's EPS estimate of $3.30. The business has a bit more controversy than the other two, because the company is a pure auto parts supplier, 34% of its sales come from China and Volkswagen (VLKAY), which has been mired in the diesel engine controversy, is its largest customer. The shares have really taken a beating this year, down 47% from its peak.
However, for more patient investors, BWA probably has the most upside since it has industry leading turbo charger and powertrain technologies and typically trades at a premium to the auto parts group at more than 15x earnings. Longer term, its top-rated fuel-efficiency technologies should continue to gain market share.
We don't know when the recent stock market turbulence will subside. However, the scare has sent a number of high quality companies to multi-year stock price lows. Buying into a market or sector selloff never feels good, but we believe that for those that are okay living with some short-term uncertainty there is a very good likelihood that the above stocks should be meaningfully higher in the next 12 to 18 months.