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3 Stocks Standing Tall in the Struggling Auto Equipment Industry

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The Zacks Automotive - Original Equipment industry is facing challenges, thanks to the global chip deficit. While the demand for vehicles is on the rise owing to preference for private transportation and gradual economic recovery, supply chain disruptions due to labor and chip crunch remain major concerns. While evolving technologies and rising demand for electrified and autonomous vehicles offer new opportunities, rising R&D expenses are playing a spoilsport.

In the near term, most auto equipment manufacturers are likely to have a tough time in balancing their revenue generation, given broader challenges and escalating expenses. Nonetheless, a few industry participants including Oshkosh Corporation (OSK), Allison Transmission Holdings (ALSN) and Tenneco Inc. (TEN) stand out as they are actively focusing on managing escalating costs for superior technology.

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.

3 Key Themes Shaping the Industry

Semiconductor Shortage a Major Concern: Auto equipment manufacturers are dependent on semiconductors, which are in short supply. Shortfall of microchips is hindering business operations of the industry participants and the chip crunch is not likely to ease any time soon. Many industry players acknowledge the risk, and expect near-term production as well as sales to be impacted. One of the leading auto equipment companies, BorgWarner (BWA) recently lowered the forecast for light vehicle and commercial vehicle production for 2021 amid chip famine, and expects the most significant impact of the semiconductor shortage to be in North America.

Growing Vehicle Demand Raises Hope: The COVID-19 pandemic triggered a push for personal mobility amid a social-distancing environment. Moreover, faster-than-expected recovery of the U.S. economy buoyed by nationwide COVID-19 vaccinations, unprecedented fiscal stimulus and an accommodative Fed is driving vehicle sales. As demand for original equipment depends directly on the sale of vehicles, things are looking up for the auto equipment industry. However, the major concern here is whether the industry will be able to meet the growing demand amid supply chain disruptions.

Mounting Costs Likely to Weigh on Margins: With the technology shift in full swing, original equipment manufacturers 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, time as well as labor, in turn resulting in high R&D spending. Additionally, cost of raw materials including steel and copper are on the rise, and are expected to mar gross profits of the firms. As such, performance of industry players will depend on their capacity to absorb costs related to manufacturing and expansion in order to capitalize on revenue-generation prospects.

Zacks Industry Rank Signals Dull Prospects

The Zacks Automotive – Original Equipment industry is a 53-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #196, which places it in the bottom 22% 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 gloomy 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. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s growth potential. Over the past year, the industry’s earnings estimates for 2021 have declined 19%.

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 Underperforms Sector & S&P 500

Over the past year, the Zacks Original Equipment industry has lagged the broader Auto sector and the Zacks S&P 500 composite. The industry has gained 29% over this period against the S&P 500’s surge of 41.1%. Meanwhile, the broader sector has rallied 81.9% in the said time frame.

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 10.03X compared with the S&P 500’s 16.8X and the sector’s 13.6X.

Over the past five years, the industry has traded as high as 11.63X, as low as 3.68X and at a median of 6.61X, as the chart below shows.

EV/EBITDA Ratio (Past Five Years)

3 Stocks Braving Industry Challenges

Oshkosh: Oshkosh manufactures and sells specialty trucks, military vehicles, fire and emergency apparatuses as well as access equipment. The acquisition of Pratt Miller, which closed in January 2021, will help Oshkosh navigate through the untapped market of uncrewed ground vehicles and enhance its offerings. The collaboration with Microvast is likely to strengthen Oshkosh’s electrification capabilities and in turn buoy its prospects. Also, the company's recent 10-year contract from the United States Postal Services to modernize the latter’s fleet of postal delivery vehicles positions it well for growth. Further, a healthy balance sheet and investor-friendly moves boost investor confidence. Flaunting a Zacks Rank #1 (Strong Buy), Oshkosh has an expected long-term earnings growth of 16.4%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: OSK

Tenneco: Tenneco — which currently sports a Zacks Rank #1 — is a designer of powertrain, motorparts, performance solutions and emission control products. The buyout of Ohlins has expanded Tenneco’s product offerings and accelerated the development of advanced original equipment intelligent suspension solutions. Focus on innovation, quality and performance across all business segments is accelerating Tenneco’s growth momentum. The firm’s emphasis on cost-savings, disciplined capex reductions and other strategic efforts are likely to shore up margins. The Zacks Consensus Estimate for Tenneco’s earnings and sales implies year-over-year growth of 909% and 16%, respectively.

Price and Consensus: TEN

Allison Transmission: Allison, which carries a Zacks Rank #2 (Buy), is a manufacturer of fully-automatic transmissions for medium and heavy-duty commercial as well as heavy-tactical U.S. defense vehicles. Acquisitions of Walker Die and C&R Tool & Engineering have enhanced the quality of its on-highway transmissions. Allison has also increased the pace of development of products that cater to electrification and fuel-cell markets for commercial vehicles. The buyout of Vantage Power and AxleTech’s EV systems division has accelerated Allison’s electrification strategy, thereby expanding its system and integration level capabilities in alternative propulsion. The Zacks Consensus Estimate for Allison’s earnings and sales implies year-over-year growth of 51.9% and 16.2%, respectively.

Price and Consensus: ALSN

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Tenneco Inc. (TEN) : Free Stock Analysis Report

Oshkosh Corporation (OSK) : Free Stock Analysis Report

BorgWarner Inc. (BWA) : Free Stock Analysis Report

Allison Transmission Holdings, Inc. (ALSN) : Free Stock Analysis Report

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