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6 undervalued US auto stocks

Glenn Freeman  |  19 Nov 2019Text size  Decrease  Increase  |  
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Morningstar believes investors are underestimating the potential of big-name carmakers Ford and General Motors and lesser-known parts suppliers such as BorgWarner and Allison Transmissions. 

Tenneco (XNYS: TEN)

Automotive emissions control, suspension and powertrain components supplier Tenneco is trading at a compelling 83 per cent discount to Morningstar's US$73 fair value estimate – having closed on Monday at US$12.35.

This follows Tenneco's trouncing of market expectations in its third-quarter 2019 results. At the end of October, it reported earnings per share of US$1.23, soundly beating the 93 cents a share expected by many market watchers.

Morningstar equity analyst Richard Hilgert highlights Tenneco's adjusted revenue growth of 6 per cent over the quarter, versus the 3 per cent decline in global light vehicle production.

This result belies management's lowering of its full-year guidance and the effect of United Auto Workers strike action on the likes of General Motors and Ford. Morningstar would have increased its fair value estimate by $1.70 on the basis of the rising time value of money since the last update, but instead left this unchanged after reducing its 2019 estimate.

Management has indicated it is evaluating strategic options to mitigate the effect of challenging market conditions and to speed up its program of debt reduction.

"We read between the lines here to mean that asset sales may be forthcoming, the proceeds from which would reduce debt," Hilgert says.

Tenneco recently completed its acquisition of Federal Mogul, which develops and distributes powertrain equipment and other automotive parts including brakes and chassis components. Its product set features well-recognised automotive parts brands such as Monroe, Walker, Anco and Champion.

Management has flagged plans to separate the new entity into two publicly traded companies.

Veoneer (XNYS: VNE)

Veoneer develops technology that supports autonomous vehicles, including radar and camera systems, software and other advanced driver assistance programs.

"We think the company has positioned itself as an integrator of technologies that are required as standard equipment by respective governments' New Car Assessment Programs," Hilgert says.

He views many of these technologies as key to vehicles receiving "coveted four- and five-star crash test ratings."

Veoneer's contracts tend to be long-term, including partnerships with the likes of General Motors, Volkswagen, Audi, Peugeot, BMW and Mercedes Benz.

In its largest market, the US, the National Highway Traffic Safety Administration said as early as 2016 that 20 automakers had voluntarily agreed to equip all new passenger vehicles with low-speed automatic emergency braking (AEB) and forward collision warning (FCW) technologies by September 2020.

By the end of 2017, AEB had become standard equipment on more than half of the vehicle models offered by four of these manufacturers. Another five had installed AEB on around one-third of their vehicles produced in 2017.

Hilgert notes that Veoneer has a "large and growing number of new contracts in development phase versus the lengthy period until revenue generation ramps up".

It typically takes four to six years before a partnership begins to generate revenue, which leads to Hilgert's estimate of net losses through 2023.

But he expects Veoneer will turn the corner into profitability from 2025.

"Global penetration of automated vehicle technologies should represent roughly 12 per cent growth in Veoneer's total addressable market, including growth in global light vehicle demand.

This is underpinned by an expectation of a strengthening euro currency, and light vehicle demand at peak levels in Europe and the US. Hilgert expects China's demand for light vehicles will weaken over 2019 and 2020 before recovering to mid-single-digit growth, and a similar recovering in developing markets.

Veoneer's share price of $US15.33 at Monday's market close sees the stock trading at a 37 per cent discount to Morningstar's US$26 fair value estimate.

Ford Motor Co (XNYS: F)

When weighing price-to-fair value estimates, automotive giant Ford is the third most undervalued stock in the category.

Having closed at US$8.95 on Monday, it's currently trading at a 25 discount to the fair value set by Morningstar US equity analyst David Whiston.

Late last month, Ford negotiated a new four-year agreement on employee pay and conditions with the United Auto Workers union. This calls for US$6 billion of new investment and the creation or retention of 8500 jobs, "but we see nothing to cause us major concern about Ford's long-term competitiveness," says Whiston. He made no change to his fair value estimate of US$12.

"We remain optimistic about Ford’s long-term prospects because the company now makes cars people actually want to own instead of vehicles that are purchased only because of heavy incentives," Whiston says.

But he concedes the company faces strong headwinds on several fronts, including:

  • Commodity prices
  • Foreign exchange rates
  • Investment in mobility and electrification technologies
  • Slowing US and China markets over the mid-term.

Ford management knows it must improve its balance sheet to combat challenges that are outside its control, such as currency and commodities.

"Based on our talks with management, many costs in areas such as marketing, product development, and testing need revamping, and these changes will take time," Whiston says.

But he likes Ford's "bold move" to slash the number of vehicle models it sells in North America to focus solely on the Focus and the Mustang.

Whiston also welcomes the wider use of platform-sharing across different vehicle models in Ford's line-up to improve economies of scale. It has reduced the number of platforms to nine, from 27 in 2007.

"In the past, Ford had a different platform in each segment for each part of the world, which wasted billions," he says.

Some more changes Whiston would like to see include more frequent product launches, as the roll-out of new vehicles has been too clustered together in the past, and a stronger luxury segment.

The Lincoln is Ford's stand-out within the premium category, but Whiston believes better product is needed, while noting that the Continental sedan is a "step in the right direction".

BorgWarner Inc (XNYS: BWA)

BorgWarner, which provides vehicle propulsion components to global automotive companies, recently saw a slight increase to its Morningstar fair value estimate, to US$58 from US$57, due to the time value of money since its last update.

Having last closed at US$44.59, it currently trades at a 23 per cent discount to Hilgert’s fair value estimate. Hilgert has also flagged the possibility of boosting his fair value by as much as US$4 by the end of 2019 due to BorgWarner's 30 October divestment of an asbestos liability subsidiary.

BorgWarner's results for third-quarter 2019 indicate the company continued to outperform overall light vehicle demand, with 4.5 per cent revenue growth versus a 3 per cent decline in global vehicle production.

Hilgert notes that management has tightened its full-year 2019 guidance on the back of falling light vehicle demand but believes this should be partially offset by the company's cost control measures and new business launches.

"Our long-term outlook for the shares of BorgWarner remains favourable based on our expectations for increasing penetration of fuel-saving technologies and powertrain electrification that enable automakers to comply with increasingly stringent clean air regulations around the world.

"High global demand for sport utility and crossover vehicles, for which BorgWarner products enable all-wheel and four-wheel drive, also supports growth prospects," Hilgert says.

BorgWarner has one of the highest exposures to electrification, but in Morningstar's view its share price has been overly discounted by the market because of its exposure to internal combustion engine powertrains.

Hilgert forecasts annualised revenue growth that exceeds global vehicle demand growth by 2-4 percentage points. The company reports US$2 billion-US$2.4 billion booked net new business backlog through 2021, which implies a 5-6 per cent average annual revenue growth rate.

General Motors (XNYS: GM)

Like Ford, GM also recently had to contend with union strike action – this saw US$1 billion wiped from earnings before interest and tax.

But Morningstar's Whiston says GM's third-quarter earnings per share remains solid at US$1.72, down 8 per cent on the same period in 2018.

"Excluding the strike, GM’s EPS would have been an all-time quarterly record," he says.

The company reduced capex guidance for 2019, to US$7.5 billion from between US$8 billion and US$9 billion, toward its goal of US$7 billion per year capital spending by 2020.

This prompted a slight increase in Whiston's fair value estimate, to US$48 from US$47 a share. With a Monday closing price of US$36.62, GM is currently trading at a discount of more than 23 per cent.

"We think General Motors' car models are of the best quality and design in decades.

"The company is already a leader in truck models, so a competitive line-up in all segments, combined with a much smaller cost base, says to us that GM is starting to realise the scale to match its size," Whiston says.

He believes GM is now making products that consumers are willing to pay more for than in the past.

"GM now operates in a demand-pull model where it can produce only to meet demand, is structured to do no worse than break even at the bottom of an economic cycle and is about to see the upside to having a high degree of operating leverage.

"The result is higher profits despite lower US market share."

Allison Transmission Holdings (XNYS: ALSN)

The world's leading manufacturer of automatic transmissions for commercial vehicles, Allison was spun out of GM in 2007 and listed separately in 2012.

Morningstar analyst Scott Pope awards Allison a narrow moat rating due to its 60 per cent share of the commercial vehicle segment – and no large-scale competitor.

Pope highlights two key factors driving demand for Allison's automatic transmission products:

  1. They improve operator efficiency by eliminating the need for operators skilled at driving manually geared vehicles
  2. Its products provide better fuel efficiency.

"Because of these benefits, Allison's products can pay back the US$3000 to US$11,000 upfront premium over manual transmissions in less than three years," Pope says.

Allison's last closed at US$45.87 a share and is trading at a 16 per cent discount to Morningstar's US$54 fair value estimate.

 

is senior editor for Morningstar Australia

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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