Tuesday, June 15, 2010

BWA; TRW, JCI - Auto parts day

Today is Auto parts day, folks. Two tier-1 firms are out with significant calls on Autos & Auto-Related sectors:

- UBS is out with a lengthy note titled: "Which Technologies Will Benefit Most from Fuel Economy Regulation?" In this report, they have identified the lowest cost technologies needed to meet US fuel economy targets. Based on their analysis, they forecast that dual clutch transmissions (DCTs) and turbochargers will have the best growth prospects. The firm is raising their 2012 to 2014 EPS estimates for Borg Warner (NYSE:BWA) to reflect the outsized growth of these technologies.

Borg Warner (NYSE:BWA) is upgraded to Buy from Neutral with a $50 price target (prev. $50).

According to UBS, BWA currently has a 35% share in turbos and is the only global supplier of wet DCTs. Consequently, BWA’s organic growth should significantly exceed that of the industry. UBS forecasts that BWA’s sales will double in the next 4 years. By 2016, they forecast that the US DCT and gas turbocharger markets will grow to $1.9bn and $1.3bn respectively from almost nothing today.

One of the most cost effective means of improving fuel economy will be to downsize engines. Automakers can downsize engine and maintain fuel economy by adding direct injection and a turbocharger. A turbocharged four cylinder engine can get similar fuel economy to a V-6 engine. UBS believes that by 2016 18% of gas engines will be turbocharged. By 2020, they expect penetration to reach 25%. Each gas turbo costs about $440/vehicle, and therefore they estimate the turbocharger market will increase to $1.3bn by 2016 and $1.9bn to 2020.

The gasoline engine downsizing trend will also accelerate in Europe. VW said that in a few years it is likely that 90% of their gasoline engines would be turbocharged. Automakers like Fiat have plans to aggressively downsize engines. Fiat plans to offer a turbocharged two-cylinder engine in Europe.

Diesel mix mitigates European exposure. 57% of BWA’s 2009 sales were in Europe, and therefore BWA will clearly be impacted by the expected declines in European auto sales. European sales are expected to decline 15-20% in the second half of this year. Beyond 2010, UBS expects flat European sales with sales down 1% in 2011 and up 1% in 2012. Despite its high regional sales exposure, they believe that BWA will significantly outperform the European market. BWA is levered to the European diesel market since almost all diesels use turbochargers. Diesels significantly underperformed the market in 2009 as diesel penetration fell from 53% in 2008 to only 46% in 2009. This implied that diesel sales declined by 15% while total industry sales declined by only 2%. Q1 2010 diesel mix was 50%, and they expect diesel mix to continue to recover in 2010.

Raising EPS estimates. UBS is raising their 2012 to 2014 EPS estimates for BWA to reflect the projected outsized growth of DCTs and gas turbochargers. They are raising their 2012 EPS estimate from $3.75 to $3.80, their 2013 estimate from $4.60 to $4.85, and their 2014 EPS estimate from $5.15 to $5.40.

- Morgan Stanley is upgrading the Autos & Auto-Related sector to Attractive from In-Line.

According to the firm, these actions reflect positive catalysts in the form of a meaningful cyclical recovery in auto production as well as significantly lower break-even levels across the industry and higher levels of sustainable profitability driven by restructuring, capacity rationalization and higher utilization. They believe these positive factors outweigh concerns surrounding near-term macro outlook in Europe as well as anticipated FX and commodities headwinds, though these could temper margins in 2H10 from their current levels.

V-shaped SAAR recovery underway though we trim 2010 SAAR expectations on slower initial ramp
US SAAR has been running at approx. 11.2 mm units in 1H2010, which is slightly above the 4Q09 run rate of 10.9 mm. Despite the sequential improvement and the start of a V-shaped recovery, the pace of recovery in the SAAR has been a bit slower than Morgan Stanley had hoped reflecting the impact of adverse weather conditions and the Toyota recall related sales stoppage in Jan-Feb and the choppy nature of the economic recovery. Their leading indicator and the drivers of new vehicle sales that they track still point to strong new vehicle sales conditions implying a sharp recovery in the SAAR and they expect a run-rate of 13-13.5 mm in the second half of the year. However, the slower SAAR rate in 1H causes the firm to trim their full year 2010 SAAR estimate to 12.3 mm from 12.8 mm units. They continue to expect a 2011 SAAR of 14.5 mm units and 2012 SAAR of 15.5 mm units.

Production levels in NA have been running at elevated levels that have been large consistent with Morgan Stanley's above consensus expectations of production. However, they believe investor concerns about unsustainable levels of production driving operating leverage are overblown. Industry inventory levels are still low enough (47 days at the end of May vs. LT average of 65 days) to need restocking of about 400-500K units even at current selling rates. They also expect SAAR to meaningfully pick up through the rest of the year -- their 12.3 mm 2010 SAAR estimate implies a 13 mm SAAR for the remainder of 2010. This implies an NA production of approx. 8.7 mm for the remainder of the year (assuming 75% domestic assembled share of sales, CA+MX sales running at April levels for the rest of the year, 65 days of inventory at exit rate SAAR of 13 mm and exports of 150K units for the rest of year), bringing them to their total NA production forecast of 11.5 mm units. If SAAR were to run at current rates for the rest of the year, they expect production of approx. 11 mm units in NA.

The company specific comments:

- TRW Automotive (NYSE:TRW) is upgraded to Overweight from Equal-Weight with a $44 price target (prev. $30), representing 48% upside.

Morgan Stanley is raising EPS estimates to $3.75 from $2.15 for 2010 and $4.40 from $3.00 for 2011, which are 10-15% above consensus. They now see sustainable operating margins at TRW in the 7-9% range vs. their previous estimate of 5-6% and well above the historical high-watermark of <5%. This, coupled with a far stronger balance sheet (net debt/EBITDA at 1.2x in 1Q vs. historic 2-3x range), leaves TRW’s financial and growth position better than at any point in its history. Valuation is also one of the cheapest in the group at 6.8x 2011e.

- Johnson Controls (NYSE:JCI) is upgraded to Overweight from Equal-Weight with a $40 price target (prev. $36), representing 33% upside.

Morgan Stanley trims 2010 EPS on FX headwinds, but raises their estimates for sustainable margins in the out-years, which drives their DCF higher. They see potential for further upside in their model, if pace of a recovery in BE (where they are below mgmt. guidance) is faster than their conservative assumptions and if JCI converts on its letter of interest issued on May 21 to acquire the Electronics and Interiors businesses of Visteon, which could improve their competitive market position in China and unlock cost synergies in NA and Europe. JCI trades below its traditional historical valuation premium at 10.2x FY11 EPS (group 10.8x, hist. 14-15x), and 5.8x EV/2011 EBTIDA (group 5.1x, hist. 6-7x).

- Borg Warner (NYSE:BWA) estimates go to $2.40 from $1.80 for 2010 and $3.45 from $3.00 for 2011, which are 5-7% above consensus. Morgan Stanley notes their bull case for BWA seems to be playing out with turbo and DCT penetration growth enabling BWA to grow faster than industry growth rates and restructuring actions finally gaining traction. They continue to believe that BWA has one of the most comprehensive portfolios of green technology related to the IC engine . BWA’s recent acquisition of a diesel emissions supplier and significant YTD program wins including Ford’s 4-cylinder Ecoboost, further strengthen this position, in firm's view. BWA trades at discount to its traditional historical valuation premium at 10.9x FY11 EPS (group 10.8x, hist. 14-15x), and 4.6x EV/2011 EBTIDA (group 5.1x, hist. 6-7x).

Notablecalls: Uummmmm, these are some tasty calls!

Not too long ago the Auto parts sector was all the rage & I suspect these two calls from UBS and Morgan Stanley will revive the animal spirits once again.

Here are the ranges I see for these 3 stocks:

- BWA will be up by at least 5% today, putting $40.50 level in play.

- TRW is a big mover. I have repeatedly seen this one up 6-8% on calls less powerful than we have today from Morgan Stanley. This one can trade $33-34 today.

- JCI has gotten beaten up, so I think 5% is prudent here. It's not as big of a mover as the other 2 but given the general tape & the powerful call, I think it could do $29+ today.

Plenty of opportunity in these today, folks. Let's see how it works out.


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