Prospects of the Zacks
Automotive - Original Equipment industry appear muted amid the global chip crisis. The industry players are likely to suffer from rising prices of raw materials and a tough labor market. Evolving technologies and rising demand for electrified and autonomous vehicles are further escalating their capex requirements, thereby affecting margins and cash flows. Most auto equipment manufacturers are likely to have a tough time balancing their revenue generation, given broader challenges and escalating expenses. In a scenario wherein cost management holds the key, a few companies like Allison Transmission Holdings ( ALSN Quick Quote ALSN - Free Report) , Meritor, Inc. ( MTOR Quick Quote MTOR - Free Report) and Hyliion Holdings ( HYLN Quick Quote HYLN - Free Report) seem relatively stronger to fend off the headwinds. About the Industry
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. Demand for original equipment depends directly on the sale of vehicles, which, in turn, is heavily reliant on economic growth and consumer confidence. Importantly, the rapidly globalizing world is opening up newer avenues for auto-equipment manufacturers who need to adapt to the changing dynamics through systematic research and development. From a future competitive standpoint, the industry players need to focus on technologies that offer the best value in a short span of time to the market.
3 Key Themes Influencing the Industry
While the demand for vehicles is on the rise amid economic growth and preference for personal mobility, the shortage of semiconductors is posing severe challenges. Auto equipment manufacturers are dependent on microchips and a shortfall of the same is hindering their business operations. Industry participants are concerned about whether they will be able to meet the growing demand for vehicles. In fact, they are of the view that the chip crunch will persist through 2022, thereby impacting the production of light and commercial vehicles, which will lower the sales of their products and adversely impact the bottom line. Chip Shortage Acting as a Killjoy: A transition toward electric and driverless cars is resulting in a fundamental restructuring of the business models of the industry. With technology shift in full swing, original equipment manufacturers (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, which is likely to clip near-term cash flows. With the industry already in disarray amid the chip crisis, the performance of the companies will largely depend on how well they can manage high R&D expenses. Big Electrification Push to Push Capex Needs:
High Commodity Costs to Weigh on Gross MarginsMost of the industry players have acknowledged that the increasing cost of raw materials is set to impact their margins. With supply chain distortions only worsening and Delta variant infections rising, commodity costs are not likely to lessen any time soon. One of the leading OEMs : BorgWarner ( BWA Quick Quote BWA - Free Report) anticipates a net negative impact from commodities in the range of $70-$90 million in 2021. A difficult labor market and elevated freight costs due to the current supply chain environment will also dent gross margins. Zacks Industry Rank Signals Drab Prospects
The Zacks Automotive – Original Equipment industry is a 56-stock group within the broader Zacks
Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #203, which places it in the bottom 19% of around 250 Zacks industries.
Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates tepid near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the six months, the industry’s earnings estimates for 2021 have declined 25.6%.
Despite the murky scenario, we will present a few stocks that one can buy or retain, given their solid growth endeavors. But before that, it’s worth taking a look at the industry’s performance and current valuation.
Industry Lags Sector & S&P 500
Over the past year, the Zacks Original Equipment industry has underperformed both the broader Auto sector and the Zacks S&P 500 composite. The industry has lost 19.1%, underperforming the sector and S&P 500’s growth of 28.9%, and 35.1%, respectively.
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.
On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 9.78X compared with the S&P 500’s 15.73X and the sector’s 11.62X.
Over the past five years, the industry has traded as high as 11.26X, as low as 3.71X and at a median of 6.96X, as the chart below shows.
EV/EBITDA Ratio (Past Five Years)
3 Stocks to Keep an Eye On
Meritor: This Michigan-based firm supplies a broad range of integrated systems, modules, and components for commercial and specialty vehicles worldwide, with leading positions in most of the markets served. The buyout of AxleTech has enhanced Meritor’s growth, and is expected to result in various commercial and operational synergies. For fiscal 2021, the company’s sales projection has been raised to $3.9 billion, indicating an increase from the year-ago level. It is on track to achieve M2022 goals that focus on new business opportunities, margin expansion and cost-containment efforts. Meritor is actively engaged in medium-duty electrification programs. It is constantly securing new business wins, which are driving electrification revenues. The company currently carries a Zacks Rank #2 (Buy) and has managed to surpass earnings estimates in each of the trailing four quarters. Over the past 60 days, the Zacks Consensus Estimate for fiscal 2021 earnings has moved up 7.5% to $2.45 a share, implying year-over-year growth of 119%. Price and Consensus: MTOR Hyliion: This Texas-based electric vehicle startup made its debut on the NYSE on Oct 2, 2020. Hyliion intends to supply electric and hybrid powertrain solutions to truck makers in a cost-effective manner. Its biggest rewarding point is that it can retrofit its technology on the existing fleets. The firm, which is still in the nascent stage, expects to generate meaningful revenues only by next year. The partnership with Dana Incorporated ( DAN Quick Quote DAN - Free Report) provides Hyliion with state-of-the-art manufacturing capabilities, thereby enabling it to achieve full-volume production of its powertrain systems. Encouragingly, the firm remains on track with its Hypertruck ERX commercialization timeline. Recently, Hyliion launched an enhanced hybrid powertrain solution, “Hybrid eX”, which marked a major milestone for the firm. It is set to commence shipping of Hybrid eX units in the coming months. The company currently carries a Zacks Rank #2 and has managed to report narrower-than-expected loss in each of the trailing three quarters. Price and Consensus: HYLN Allison: Headquartered in Indianapolis, Allison is the largest manufacturer of fully-automatic transmissions for medium and heavy-duty commercial and heavy-tactical U.S. defense vehicles. Acquisitions of Walker Die and C&R Tool & Engineering have enhanced the quality of its on-highway transmissions. Buyouts of Vantage Power and AxleTech’s EV systems division have accelerated Allison’s electrification strategy, thereby expanding its system and integration level capabilities in alternative propulsion. The company projects net sales in the band of $2,325-$2,475 million for 2021, suggesting growth from $2,081 million generated in 2020. Its investor-friendly moves also instill optimism. Allison currently carries a Zacks Rank #3 (Hold) and has managed to beat earnings estimates in three of the trailing four quarters. Over the past 60 days, the Zacks Consensus Estimate for fiscal 2021 earnings has moved up 2.3% to $4.07 a share, implying year-over-year growth of 55%. Price and Consensus: ALSN