3 reasons car-parts stocks are beating the market, and why the rally can continue

  • By Al Root,
  • Barron's
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Stocks of auto-parts suppliers are on fire because the car business has bounced back faster than anyone expected. More gains could be on the way, based on car suppliers’ trading history.

Magna International (MGA) was the latest auto-parts company to report better-than-expected third-quarter numbers. It said Friday morning it earned $1.95 a share from $9.1 billion in sales, much better than the $1.39 in per-share earnings and $9.1 billion in sales Wall Street was looking for.

Earnings were up year over year, blowing past even the highest analyst estimate of $1.67 a share.

It’s good news, but the surprise isn’t all that surprising. Ford Motor’s (F) and General Motors’ (GM) earnings both far exceeded expectations as car sales and production bounced back faster than Wall Street expected from pandemic-induced lows in the second quarter.

Earnings for every single component of the Russell 3000 Auto & Auto Parts index have beaten Street projections so far. The average “beat” is 120%, meaning earnings have been more than twice as high as expected.

Magna shares were up 4.2% in Friday trading. The average gain of stocks in the Auto & Auto Parts Index is about 11% over the past month, better than the 5% and 2% returns of the S&P 500 (.SPX) and Dow Jones Industrial Average (.DJI).

Things are getting better for auto suppliers from a cyclical, secular, and company-specific perspective. Cyclically, car sales are rising and dealer inventories are low. Both are positive factors for 2021 sales.

Secularly, electric-vehicle penetration is increasing. And autonomous driving—also called active safety—solutions are proliferating as well. That means more content per car for many auto suppliers.

The final positive factor is that amid the pandemic, many suppliers have reduced costs, giving earnings another boost. “Our strong third quarter results reflect the actions we have taken to reduce discretionary and structural costs in the face of the lower levels of vehicle production,” said Magna CEO Don Walker in a news release.

The recent rally leaves auto suppliers trading for roughly 13 times estimated 2021 earnings per share. That’s up a little compared with recent history, but still a substantial discount to the broader market’s multiple of about 21 times.

Auto stocks typically aren’t valued as highly as the market as a whole, but when things are improving, the parts sector has traded at about 75% of the S&P 500’s price/earnings ratio. Today, that would be roughly 16 times forward earnings estimates, up about 20% from today’s levels.

That suggest there is room for the sector to run, though it is only one factor to consider. The performance of the overall economy and car sales will determine the direction of the industry. and parts stocks, in 2021.

Barron’s recently wrote positively about Magna, saying it stood to benefit more than other suppliers from more EV sales. Since the article appeared, Magna and Fisker (FSR) announced a manufacturing agreement and Magna stock is up about 13%. The S&P 500 is flat over the same span.

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