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Auto Equipment Industry Outlook: Cost Headwinds to Prevail

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The Zacks Automotive - Original Equipment industry consists of companies that engage in the designing, development and manufacture of automotive components used for producing vehicles. These components include engine, gearbox parts, drive axle, steering, suspension and brakes. Demand for original equipment depends directly on the sale of vehicles.

Let’s take a look at the industry’s three major themes:

  • Evolving technology is driving demand: Increased focus on developing technically enhanced and fuel-efficient vehicles in compliance with environment and safety standards has been amplifying demand for high-quality and cost-effective auto components and equipment.
  • Cost management needs more focus: While rising demand is helping the industry participants generate better revenues, production costs are yet to be managed efficiently to alleviate margin pressure. High tariffs on raw materials are taking a heavy toll on the players by raising their production costs. Additionally, R&D expenditure and developing production lines to manufacture components require significant investments.
  • Competition with local players is a concern: Maintaining global competitiveness, mostly against local players, is a key challenge for the industry participants. In order to lower shipping costs, manufacturers will have to expand their global footprint. However, localized production, maintaining supply base and product development in other countries require significant expenses.

Zacks Industry Rank Indicates Weak Prospects

The Zacks Automotive - Original Equipment industry is a 42-stock group within the broader within the broader Zacks Auto sector. The industry currently carries a Zacks Industry Rank #223, which places it in the bottom 13% of approximately 256 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak 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 bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Over the past year, the industry’s earnings estimate for the current year has moved down by 8.9%.

Despite the industry’s bleak near-term view, we will present a few auto original equipment stocks to consider for your portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Lags Sector & S&P 500

Over the past year, the Zacks Automotive - Original Equipment industry has lagged the broader Auto sector as well as the Zacks S&P 500 composite. The industry has declined 24.6% over this period compared with the S&P 500’s rise of 5.1% and broader sector’s fall of 18.8%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the trailing 12-month enterprise value-to-EBITDA (EV/EBITDA), which is a commonly used multiple for valuing auto stocks, the industry is currently trading at 5.12X, lower than the S&P 500’s 10.64X. Additionally, the industry’s figure is below the sector’s trailing-12-month EV/EBITDA of 7.61X.

Over the past five years, the industry has traded as high as 11.32X, as low as 5.06X and at a median of 7.2X, as the chart below shows.

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

Bottom Line

Rising demand for electrified and autonomous vehicles offers good growth prospects for the industry participants. However, in the near term, the performance of these companies will depend on their capacity to absorb costs related to manufacturing and expansion in order to capitalize on the huge revenue-generation prospects.

The only stock within the Zacks Original Equipment space, which currently sports a Zacks Rank #1 (Strong Buy) is Allison Transmission Holdings, Inc. (ALSN - Free Report) ). You can see the complete list of today’s Zacks #1 Rank stocks here.

Allison Transmission: The Zacks Consensus Estimate for the current-year EPS of this Indianapolis, IN-based supplier of fully-automatic transmissions has moved 0.7% north over the past 30 days. Over the past six months, shares of Allison Transmission have increased 6.7%.

Price and Consensus: ALSN

We are also presenting two stocks with a Zacks Rank #2 (Buy) that are well poised for growth.

Oshkosh Corporation (OSK - Free Report) : The consensus EPS estimate for this Oshkosh, WI-based vehicle body manufacturer has been revised 9.2% upward for the current fiscal year in the last 30 days. Oshkosh’s stock has rallied 13.7% over the past month.

Price and Consensus: OSK

Tower International, Inc. (TOWR - Free Report) : The consensus EPS estimate for this Livonia, MI-based manufacturer of automotive structural metal components and assemblies has been revised 2.9% upward for the current year over the last 30 days. Over the past six months, the company’s stock has increased 2.6%.

Price and Consensus: TOWR

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