[ANALYST REPORT] Auto parts: Formerly sidelined players gaining attractiveness

 
Firms with robust top-line growth generally command high valuation multiples, but often see shares plunge if sales stall or profitability deteriorates, and even if such adversity is overcome, shares can rebound sharply even if valuation multiples do not. We focus on stocks with low price-to-sales ratios (P/S)—overly punished for flaws—that boast solid top-line growth and thus provide investment opportunities.

Firms with robust top-line growth generally command high valuation multiples, but often see shares plunge if sales stall or profitability deteriorates, and even if such adversity is overcome, shares can rebound sharply even if valuation multiples do not. We focus on stocks with low price-to-sales ratios (P/S)—overly punished for flaws—that boast solid top-line growth and thus provide investment opportunities.

● Parts makers that suffered from plunging share prices over the past two years—despite solid top-line growth—tended to be those: 1) seeing growth slow in China;

2) with exposure to EMs suffering from currency depreciation; and 3) excluded from the EV value chain. Slowing growth in China might be offset by entering new markets and diversifying customer bases, while EV parts (despite boasting high growth potential), should only contribute marginally to earnings within five years.

Parts makers currently posting earnings growth and that boast healthy financials are more likely to adapt to industry change.

● Attractive sector players include those with visible top-line growth and that have seen shares shed over 50% during the preceding two years (on margin squeeze and long-term trend worries). Companies with low P/S ratios should see top-line growth and profitability improvements through 2018, if: 1) Hyundai Motor and Kia Motors [HMC/Kia] see sales rebound; 2) the automakers construct more plants abroad; and 3) they diversify client bases. Hyundai Wia, NVH Korea, and Korea Fuel-Tech meet such criteria as two years of corrections have them trading at 0.3xP/S, with all three boasting healthy financials, approximate debt ratios of 100%, and profit rebounds on the horizon.

WHAT’S THE STORY?

Utilizing P/S: Sales in the auto sector are indicative of growth, backed by fixed asset investment (even when ASPs stay flat), with low- price-to-sales ratios (P/S) stocks able to rally if profitability recovers, even if their valuation multiples do not follow suit.

• Mando shines: After bottoming around KRW108,000 in Aug 2015—on concerns over corporate governance and slowing demand in China—shares in Mando have soared a sector-leading 130%, thanks to: 1) demand stimulus in China; 2) reduced nonoperating volatility; and 3) it regaining potential as an electronic parts maker.

• Attractive P/S plays: Hyundai Wia, NVH Korea, and Korea Fuel-Tech have high top-line growth potential, but saw shares fall by over 50% during the past two years to trade at 0.3x P/S, with all three: 1) seeing earnings growth slow in China: 2) exposed to EMs with depreciating currencies; and 3) excluded from the EV value chain

Flaws to address: Subsidiaries of domestic parts makers operating in EMs have turned profitable amid currency stabilization, with Hyundai Motor (HMC) and Kia Motors seeing global shipments beginning to recover after recently adjusting inventories.

• New plants: We expect HMC/Kia to see global shipments grow through 2018, as the: 1) former opens its fourth and fifth factories in China this year and next, respectively; and 2) latter opened one in Mexico last month and could open another in India.

• Market share gains: Sluggish earnings by subsidiaries operating in China should be offset by an increased engine market share in HMG (Hyundai Wia) and client-base diversification (NVH Korea and Korea Fuel-Tech).

• ASP hikes, easing competition: The key products of Korean parts makers fall outside of the EV value chain, but they can improve product mixes by making eco-friendly parts.

Source: Samsung Securities https://www.samsungpop.com/