Auto parts suppliers were some of the star stocks of 2009, with gains of 50 per cent or more typical of the sector. Yet there's sentiment there's still time to go along for the ride.
Wells Fargo Securities analyst Richard Kwas upgraded Aurora, Ont.-based Magna International Inc. and Tenneco Inc. - along with the entire supplier sector - to "outperform" yesterday. For Magna specifically, Mr. Kwas bumped his 2010 earnings per share estimate to $3.65 (U.S.) from $3.00, and his target price range from $52-$57 to $69-$75.
Mr. Kwas looks bearish compared with the Merrill Lynch analyst team led by John Murphy. Mr. Murphy raised the Magna 2010 EPS estimates to $4.35 from $2.80 on Tuesday and the target price to $72 from $60. The Merrill Lynch team is now above consensus on all the parts suppliers it covers, with some of its estimates more than 50 per cent above the mean.
Underlying this optimism: forecasts of big rebounds from auto makers in 2010. Mr. Kwas' upgrades came as a result of bumping his production forecasts from 10 million vehicles to 10.7 million vehicles in 2010.
Merrill Lynch, which had already been forecasting 11 million vehicles to roll off the lines this year, jacked up its estimate to 12 million this week.
Any of these numbers would represent a massive increase from 2009; when the books close, most analysts think right around nine million light vehicles will have been produced.
By comparison, according to Merrill Lynch, 2006 saw production of more than 15 million cars, and the figure was about 12.6 million as recently as 2008.
"To say it was a down year doesn't do it justice," said Morningstar auto industry analyst David Whiston. "It was an absolute catastrophe. To say 2009 is the new norm is ridiculous."
The auto suppliers' 2009 gains came when investors began to embrace that view and put thoughts of industry-wide insolvency in the rear-view mirror.
Some of the most troubled issues early in the year posted outsized gains.
Dana International, 74 cents a share at the beginning of 2009, closed at $10.84, up more than 1,300 per cent. Tenneco and TRW Automotive Holdings Inc., each around $3 when the year began, each gained more than 500 per cent.
Magna, widely perceived as having one of the industry's best balance sheets, was never in the zombie category, so its 2009 upside was limited to a mere 70 per cent. Yet the excitement hasn't stopped there: Magna, Tenneco and competitor BorgWarner Inc. are all up more than 10 per cent in the first four days of trading this year.
Analyst David Leiker of Robert W. Baird & Co. is one who thinks these stocks have gotten ahead of themselves. On Dec. 23, before the recent runup, Mr. Leiker sounded a cautionary note that recent price levels in the supplier sector seemed to be driven by unusually high production levels. The fourth-quarter 2009 and first-quarter 2010 numbers implied annual production of 12 million, while consumer demand is more likely in the range of 10 million to 11 million, Mr. Leiker believes.
"We believe a 10-15 per cent pullback is likely in the auto [supplier] group as current U.S. production levels adjust downward," Mr. Leiker wrote in the Dec. 23 note.
While there's some disagreement over how much production will grow - and, by extension, how much the suppliers' top lines will gain - analysts say the harsh cost cutting the companies went through in 2009 makes them well positioned for big gains in earnings.
When revenues drop sharply and quickly, companies often can't cut costs fast enough, and profits suffer - or turn to losses. But once the costs are reduced to reflect the new, lower level of sales, any boosts to revenue quickly goose earnings.
Mr. Kwas, in adding 65 cents to his 2010 estimate for Magna, sees only 20 cents of that gain coming from gains in gross profit. A full 44 cents will come from a lower level of selling, general and administrative expenses than he previously forecast.
Indeed, Mr. Kwas now sees SG&A at 5.7 per cent of 2010 revenue of $20.66-billion - a smaller ratio than in 2007, when Magna posted $26.07-billion in sales.
Still, the improved cost structure of the industry is not a secret.
The only question now is whether Magna and its counterparts can deliver on what have quickly changed from low expectations to a high bar. Says Mr. Whiston of Morningstar: "Earnings will be much, much better - but I think the market's priced much of that in. I don't see any bargains in the sector."