Future Cars, Auto Industry Recovery Put Components Suppliers On Strong Footing

Jul 19, 2023

The auto industry is deep into its most intensive reinvention in a century. That process got seriously underway after U.S. auto sales peaked in 2018 and it accelerated despite severe economic upheaval wrought by the coronavirus pandemic. Vendors hustling to supply the parts and components for the industry's ambitious future cars have gone along for the bumpy ride.

Following a tough year for component suppliers in 2022, outlooks and forecasts point to stronger performance ahead. Shares of Aptiv (APTV), BorgWarner (BWA), Visteon (VC), Autoliv (ALV) and Adient (ADNT) have all pulled back after a late-year rally in 2022.

But group earnings began turning higher in the third quarter. And analyst outlooks for 2023, according to FactSet, call for an industrywide advance.

"Right now, along with other parts of the market, these stocks have been reacting to what seems to be a better outlook for 2023 than 2022," said Morningstar analyst Richard Hilgert.

Robust outlooks helped keep the group's pullback in check. BorgWarner and Autoliv took advantage of the pause to shape six-week flat bases. Adient built a handle on a yearlong base pattern.

The chip shortage, which severely disrupted vehicle production during the pandemic, seems to be alleviating. And analysts say that better, steadier chip production is just what the auto suppliers need.

"That makes for a big difference in operating leverage and a big difference in margin comparisons" for 2023 vs. 2022, Hilgert said.

In 2023, new vehicle inventories are recovering while demand headwinds rise. That is a reversal of 2022, when demand outpaced supply and partially built cars stockpiled in manufacturer parking lots waiting for chips and other vital parts.

Improving new-car inventory means more manufacturing and more demand for parts. That means more demand for electronic and software systems from Aptiv, which grew out of General Motors' (GM) Delphi electronics unit and plays a key role in GM's transition to a software-focused company.

It also results in more demand for a broad range of other companies such as BorgWarner. Traditionally a drivetrain components supplier, the Michigan-based supplier has quickly maneuvered into a role as a top supplier of battery systems and electric drive technologies.

In addition, new cars are more expensive than ever. That owes partly to supply-demand imbalance created during the pandemic, but also due to the advanced technologies packed into the rising future cars.

Customer cost recoveries also helped their revenue and margin, Hilgert said. In other words, the suppliers successfully negotiated to pass higher raw material costs to their OEM (original equipment manufacturer) customers.

On Feb. 9, BorgWarner reported full-year 2022 results ahead of guidance.

Sales grew 12% in the final quarter on higher demand for products and slightly higher industry production vs. a year ago. BorgWarner also cited "the impact of commercial negotiations" with automaker customers.

The company predicts a 7%-12% sales increase in 2023, well below 2021's 46% surge but a reassuring number given global macro uncertainties. Aptiv and BorgWarner both plan to announce first-quarter results on May 4.

In this young year, several supplier stocks formed bases or broke out after recent rallies.

APTV stock topped a 114.17 buy point from a cup base in early February. BWA stock cleared a 43.49 cup-with-handle buy point in January. ALV topped a 93.88 handle buy point in a long and deep base.

But as the market pulled back through mid-March, auto supplier stocks generally undercut their buy points and shorter-term levels of technical support.

The Auto-Suppliers group, as a whole, also fell off sharply. From a No. 16 ranking out of 197 industry groups tracked by IBD six weeks ago, it has since fallen to No. 87.

In terms of relative strength, Visteon earns an RS Rating of 93 out of a best-possible 99. That means the supplier of automotive cockpit electronics has outperformed 93% of all stocks in IBD's database over the past year. BorgWarner also has a 93 RS Rating. The highest RS Rating in the industry group is held by Racine, Wis.-based Modine Manufacturing (MOD), which boasts a 98 RS Rating.

Many Tier 1 suppliers like BorgWarner assume that global light vehicle production this year will be flat to up in the low single digits. Though auto suppliers face several challenges, from the chip shortage to the war in Ukraine to inflationary cost pressures, that guidance disappointed the Street.

Morningstar's Hilgert had pegged a global light vehicle output gain of 2%-6%. He told IBD that the suppliers' recent guidance seemed "overly pessimistic."

Excluding the impact of currency, divestitures and acquisitions, organic revenue for BorgWarner and Autoliv jumped by double-digits in Q4, far outperforming growth in global light vehicle production.

The companies benefited from new business and higher pricing, as well as customer cost recoveries.

Visteon expects double-digit growth above light vehicle production over the next three years, driven by its next-gen product portfolio. Those products include cockpit domain controllers, displays and battery management systems. It also provides modules for internet-connected cars and an open software platform for autonomous driving.

Its biggest customer is Ford (F). Deutsche Bank analyst Emmanuel Rosner rates Visteon a buy, for its "best-in-class growth profile" and "meaningful margin expansion over the midterm." Rosner raised his price target on VC stock to 190 from 172 in mid-February. Visteon reports its first-quarter results on April 27.

For suppliers, the trends that will define future cars — like Advanced Driver Assistance Systems (ADAS), autonomous vehicles (AVs) and electric vehicles (EVs) — are a big positive.

Those trends tap what many car buyers are looking for in their next purchase: a safe, connected, electric vehicle.

Hilgert considers Aptiv "probably the biggest beneficiary in revenue growth potential" from these trends. BorgWarner is a beneficiary "in powertrain areas despite having exposure to ICE (internal combustion engines)," he added.

Dublin-based Aptiv supplies a vehicle's electrical backbone, including wiring assemblies and harnesses, connectors, and more. It also provides infotainment and connectivity systems, passive and active safety electronics, and advanced driver assist technologies, as well as software for these systems.

Aptiv's earnings are rebounding strongly though still below pre-pandemic levels. Earnings per share jumped nearly 31% in 2022, despite a weak first half of the year. Its largest customers in addition to GM are Stellantis (STLA) and Volkswagen (VWAGY).

BorgWarner makes undercarriage components for ICE vehicles, as well as products that reduce emissions and improve engine power and efficiency, such as turbochargers. For EVs, it also produces electric motors, battery management systems, battery packs and modules.

The company's earnings have already surpassed pre-pandemic levels, growing 11% in 2022. Its biggest customers are Ford and Volkswagen.

Automakers need its ICE technology to be compliant with clean air regulations. And "growth in the electrification side of its business is tremendous," Hilgert said.

By 2025, BorgWarner expects to generate 45% of revenue from electric vehicles vs. about 6% in 2022.

Despite an upbeat outlook centered on future cars, suppliers face a number of near-term hurdles. Those range from wage inflation and logistics issues to higher energy costs and a softening global macro outlook.

Yet outlooks for the current quarter and year are upbeat.

For the full year, analysts polled by FactSet expect Aptiv earnings to grow 30% per share as revenue rises 11%. Aptiv EPS are seen growing a further 42% in 2023.

BorgWarner earnings are set to increase 6% in 2023, then reach 16% growth in 2024, with revenue gains around 8% both years.

Visteon is likely to grow earnings 36% in both 2023 and 2024 and boasts expanding margins. Its balance sheet is in the best shape in years, Deutsche Bank's Rosner says, and free cash flow is set to ramp up considerably.

Adient, the automotive seating specialist, is poised for a 181% earnings surge in 2024. Autoliv, maker of passive safety air bags and seat belts, is expected to grow earnings 48% in 2023 and a further 42% in 2024. Autoliv reports Q1 results on April 21.

For the suppliers, demand indicators include auto manufacturer sales volumes, inventory levels and production.

At this point, the Street expects sales volumes to increase because of an unusually high amount of back orders.

"It's good for suppliers in the sense that automakers will still need to keep producing vehicles," Hilgert said.

But he warned of "some softening at margin" as rising interest rates and inflation start to sap budgets and discourage car buyers.

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