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4 Auto Equipment Stocks to Bank on Industry Tailwinds

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The Zacks Automotive - Original Equipment industry is expected to witness growth on rising demand for vehicles amid coronavirus-led preference for personal mobility and economic recovery hopes. A shift toward electric vehicles (EVs) and self-driving cars has made it necessary for industry players to reorient their business model for adapting to the changing dynamics through systematic research and development.

Evolving technologies and rising demand for electrified as well as autonomous vehicles (AVs) offer new opportunities to industry participants. The industry’s success depends on how well the players manage escalating costs for mass manufacturing and superior technology. Companies including Magna International Inc. (MGA - Free Report) , Gentex Corporation (GNTX - Free Report) , Meritor Inc. (MTOR - Free Report) and American Axle & Manufacturing Holdings, Inc. (AXL - Free Report) are likely to emerge as winners from this upbeat industry.

Industry Overview

The Zacks Automotive - Original Equipment industry includes companies that engage in the designing, manufacture and distribution of automotive equipment components used for manufacturing vehicles. A few of the components manufactured by the participants include drive axle, engine, gearbox parts, steering, and suspension as well as brakes.

3 Trends Charting the Future of Auto Equipment Industry

Growing Vehicle Demand: Demand for original equipment depends directly on the sale of vehicles, which, in turn, is heavily reliant on economic conditions and business cycles.The vaccination drive and $900 billion coronavirus relief package lead to cautious optimism about U.S. economic recovery in 2021. The auto market has also gotten back into gear, following the virus-led disruptions, riding on pent-up demand, easier credit conditions and the shift toward private transportation. All these factors are likely to boost the demand for vehicles, in turn enhancing the prospects of equipment providers.

Technological Advancement Offering New Opportunities: Widespread usage of technology and rapid digitization are resulting in fundamental restructuring of the automotive market, thereby providing significant opportunities to original equipment manufacturers (OEMs). With EV and AV trends getting hotter with each passing day, OEMs are sharpening their focus on developing technically enhanced components. Increasing popularity of fuel-efficient vehicles amid stringent emission norms has been amplifying demand for high-quality and cost-effective auto components, as well as equipment. For instance, one of the major players in the industry, BorgWarner (BWA - Free Report) expects that hybrid and electric technologies will be the firm’s major revenue drivers and significantly boost backlog, going forward. 

Cost Management Holds the Key: With the technology shift in full swing, OEMs have to develop and upgrade their offerings to remain on par with the evolving trends in the automotive market. The new features, upgrades and component designs call for abundant capital, time as well as labor, in turn resulting in high R&D spending. Production costs are to be managed efficiently to alleviate margin pressure. Performance of industry players will depend on their capacity to absorb costs related to manufacturing and expansion in order to capitalize on huge revenue-generation prospects. Also, from a future competitive standpoint, equipment manufacturing companies have to focus on technology that offers the best value in a short span of time to the market.

Zacks Industry Rank Paints a Promising Picture

The Zacks Automotive – Original Equipment industry is a 47-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #71, which places it in the top 28% of around 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates strong near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Lags Sector, Outperforms S&P 500

Over the past year, the Zacks Original Equipment industry has underperformed the broader Auto sector but topped the Zacks S&P 500 composite. The industry has gained 19.2%, underperforming the sector’s rally of 105.8%. Nonetheless, the industry’s growth compared favorably with the S&P 500’s rise of 17.7%.

One-Year Price Performance

Industry’s Current Valuation

Since automotive companies are debt laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of non-cash expenses.

On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 10.92X compared with the S&P 500’s 17.23X and the sector’s 21.45X.

Over the past five years, the industry has traded as high as 10.92X, as low as 3.76X and at a median of 6.41X, as the chart below shows.

Trailing 12-Month Enterprise Value-to-EBITDA (EV/EBITDA) Ratio

4 Key Picks

Magna: Based in Canada, Magna is one of the most diversified automotive parts suppliers in the world. Its broad range of products and services offers the firm a competitive edge. Magna’s strategic collaborations and acquisitions, along with expansion of business through joint ventures as well as hub openings are fueling its prospects. Healthy balance sheet of the firm, with low leverage and high liquidity, bodes well. Its commitment to return shareholders’ capital via dividends and buybacks is also commendable. Sporting a Zacks Rank #1 (Strong Buy), Magna has an expected long-term earnings growth of 5.4%. The firm’s 2021 earnings and sales estimates imply year-over-year growth of 97% and 19.3%, respectively. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price & Consensus: MGA

Meritor: Headquartered in Michigan, Meritor is an automotive parts manufacturer, supplying a broad range of integrated systems, modules and components for commercial, as well as specialty vehicles worldwide.While Meritor — which currently sports a Zacks Rank #1 — has successfully executed the three-year M2019 program, it is on track to achieve M2022 goals that focus on new business opportunities and margin expansion. The buyout of AxleTech has enhanced Meritor’s prospects and is likely to result in various synergies. The firm’s 2021 earnings and sales estimates imply year-over-year growth of 82.9% and 15.5%, respectively.

Price & Consensus: MTOR

American Axle: Michigan-based, American Axle is a leading supplier of driveline and drivetrain systems, modules, as well as components for the light vehicle market. The firm’s broad product portfolio and customer base are generating impressive results. Strategic acquisitions and divestments are streamlining American Axle’s business. Continuous investments in innovative and advanced propulsion solutions offer growth visibility. Sporting a Zacks Rank #1, American Axle has an expected long-term earnings growth of 8.1%. The firm’s 2021 earnings and sales estimates imply year-over-year growth of 1.093% and 19.7%, respectively.

Price & Consensus: AXL

Gentex: Michigan-based Gentex is engaged in supplying automatic-dimming rear-view mirrors and electronics to the automotive industry; fire protection products to the fire protection market; and dimmable aircraft windows to aviation markets. Impressive product launches, unique technology platforms and aggressive capital-deployment strategy have been aiding the firm. Gentex’s Integrated Tool Module and HomeLink have significant growth opportunities, going forward. The company’s growth avenues in tech products diversify and enhance prospects. Carrying a Zacks Rank #2 (Buy), Gentex has an expected long-term earnings growth of 2.6%. The firm’s 2021 earnings and sales estimates imply year-over-year growth of 42.5% and 18.5%, respectively.

Price & Consensus: GNTX

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