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2 Auto Replacement Stocks Holding Steady Despite Industry Woes

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The shift toward electric and self-driving vehicles requires the Zacks Automotive Replacement Parts industry to realign business models. To thrive, companies must create comprehensive plans to capitalize on changing market trends while managing high operational costs. High raw material costs, unfavorable currency exchanges and logistical challenges hurt profit margins but the increasing lifespan of vehicles provides an opportunity. Industry players LKQ Corp (LKQ - Free Report) and Dorman Products (DORM - Free Report) stand out for their strategic acquisitions and investor-friendly moves.

Industry Overview

The Zacks Automotive - Replacement Parts industry comprises companies that engage in the production, marketing and distribution of replacement components for the automotive aftermarket. The industry players offer replacement systems, components, equipment and parts to repair as well as accessorize vehicles. Some important auto replacement components are engine, steering, drive axle, suspension, brakes and gearbox parts. The auto replacement market is somewhat less exposed to business downturns as consumers are more inclined to spend on replacement parts to maintain their vehicles rather than splurge on new ones. Consumers can either opt for repairing vehicles on their own or avail professional services for the same. The industry is undergoing a radical change, with evolving customer expectations and technological innovation acting as game changers.

Factors at Play

Cost & Inflationary Pressure: The auto replacement industry faces challenges from high raw material and labor costs. While raw material costs have moderated, they remain above pre-pandemic levels. With inflation running hotter than expected, there is much uncertainty regarding the timing of the Fed interest rate cut. This sticky inflation may squeeze the margins of auto replacement firms. Additionally, the industry's global reach exposes companies to risks from foreign exchange fluctuations, which can affect earnings and margins.

Logistical Challenges Persist: The auto replacement sector faces challenges due to supply chain vulnerabilities exacerbated by shipping disruptions, including the Red Sea crisis and the recent Baltimore bridge collapse. These disruptions strain the resilience of the auto supply chain and drive up transportation costs.Top of Form

Tech Innovations Strain Profits: The growing adoption of electric vehicles has led to significant investments in advanced automotive components. However, the high costs of these technologies pose a challenge to the profitability of auto replacement parts. As the industry evolves to meet shifting market demands, companies must continually improve and refresh their products, requiring substantial capital investment and research and development expenses. These costs are likely to put pressure on operating margins and cash flows within the industry.

Vehicle Longevity a Silver Lining: Per S&P Global Mobility report, the average age of cars and light trucks in the United States is now 12.5 years. This extended lifespan is advantageous for the automotive replacement industry, as older vehicles require ongoing repairs and maintenance to remain operational. As the average age of vehicles increases, demand for automotive replacement parts rises as consumers invest more in maintaining their aging cars.

Zacks Industry Rank Signals Gloomy Prospects

The Zacks Automotive – Replacements Parts industry is part of the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #234, which places it in the bottom 7% 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 bleak 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 a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. Year to date, the industry’s earnings estimates for 2024 have moved 2.7% south.

Despite the industry’s muted near-term outlook, we will present you with two stocks that are worth considering. But before that, let's take a look at the industry’s stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Automotive – Replacement Parts industry has underperformed the Auto, Tires and Truck sector and the Zacks S&P 500 composite over the past year. The industry has declined 7.1% against the sector and the S&P 500’s growth of 5.4% and 25.1%, 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 trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 10.26X compared with the S&P 500’s 14.93X and the sector’s trailing 12-month EV/EBITDA of 14.59X. Over the past five years, the industry has traded as high as 13.83X, as low as 7.38X and at a median of 10.65X, as the chart below shows.

EV/EBITDA Ratio (Past Five Years)

2 Stocks Worth a Watch

Dorman: Based in Pennsylvania, the company is a key player in the motor vehicle aftermarket industry, focusing on replacement and upgrade parts. Dorman consistently expands its product line, introducing hundreds of new direct replacement parts and assemblies designed to match or improve upon the performance of original equipment. In 2023, the company reached record annual sales of $1.93 billion, marking a 13% increase year over year.

The acquisition of Super ATV has significantly boosted the company's overall prospects. Dorman's dedication to regular product launches and ongoing innovation fuels its sustained growth. With a strong balance sheet, a manageable debt-to-capitalization ratio of 33% (compared to the industry average of 52%) and ample liquidity, Dorman is well-poised for success. Investor-friendly moves via share buybacks further instill confidence.

The Zacks Consensus Estimate for DORM’s 2024 sales and earnings implies year-over-year growth of 3.9% and 22.2%, respectively. The consensus mark for 2024 and 2025 EPS has moved north by 34 cents and 44 cents, respectively, over the past 60 days. Dorman currently sports a Zacks Rank #1 (Strong Buy) and has a VGM Score of A.

Price & Consensus: DORM

You can see the complete list of today’s Zacks #1 Rank stocks here.

LKQ: Headquartered in Illinois, LKQ is one of the leading providers of replacement parts, components and systems. The acquisition of Uni-Select Inc. for $2.1 billion, completed in August 2023, has bolstered its global automotive vehicle parts distribution business. By the third year, the strategic acquisition is expected to generate an annual run-rate cost synergy of $55 million.  The company’s 1 LKQ Europe program is aiding the European segment with robust revenues and EBITDA growth and is expected to be a driving force in future productivity improvements.

Strong FCF generation and balance sheet strength bode well. The company generated FCF of around $1 billion in each of the last four years, and remains on track to achieve $1 billion for 2024 as well. Investment-grade ratings from Standard & Poor’s, Moody’s and Fitch instill confidence.LKQ is committed to maximizing shareholders’ value via dividends and share repurchases.

The Zacks Consensus Estimate for LKQ’s 2024 sales and earnings implies year-over-year growth of 10.4% and 6.5%, respectively. The consensus mark for 2025 sales and EPS suggests an uptick of another 4% and 10.3%, respectively, on a year-over-year basis. LKQ currently carries a Zacks Rank #3 (Hold) and has a VGM Score of B.

Price & Consensus: LKQ


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