12/28/2015 0 Comments
The State of the Global Auto Market
The two largest vehicle markets, China and the US, are both showing signs of strength. TrueCar and Kelley Blue Book both forecast US December auto sales to be 1.7 million, or 18 million saar, representing 13% growth over December 2014. For the full year 2015, US vehicle sales are expected to be 17.5 million, 6% above 2014. IHS Automotive estimates US vehicle sales will increase to 17.8 and 18.2 million in 2016 and 2017, around 2% growth. These estimates look to be a bit on the conservative side to me. The automotive market has continued to surprise to the upside during 2015. I don't see that changing in 2016. I think 5% growth is more likely than 2%. The automobile industry is experiencing a secular growth spurt driven by electrification and digitization. These trends will take years to transform the industry and vehicle sales will continue to benefit as demand grows for cars with these new technologies.
China Vehicle Sales Make Strong Rebound in November
The China Association of Automobile Manufacturers, CAAM, announced a bounce back in China vehicle sales in November to 2.51 million, up 20% year-over-year. China vehicle sales for the full year 2015 are expected to be 3% above 2014. Dong Yang of CAAM estimates 2016 growth in China vehicle sales will be in the 5-7% range. PwC estimates 25 million units in 2016 or 8% growth.
US Vehicle Market Expected to Remain Strong
US vehicle sales are correlated to the unemployment rate and housing starts. Both are pointing to continued strength in vehicle sales. I downloaded historical data from FRED and regressed unemployment and housing starts onto US vehicle sales. I found the R squared coefficient between the unemployment rate and US vehicle sales to be between 53% and 65% (dependent upon the time frame used). The R squared between housing starts and US vehicle sales is between 51% and 58%. When I added in population and regressed unemployment and population onto US vehicle sales in a multiple regression, the R squared increased to the 63% to 66% area. I expect the strength in unemployment and housing starts will continue into 2016. Ample credit is available to keep vehicle sales growing. The Fed is expected to progress slowly during this tightening cycle. Therefore, the slow rate of tightening is not going to bring down vehicle sales in the foreseeable future.
Gentherm's Value Proposition
I am not a big fan of the auto OEMs (there's only 2 left in the S&P, GM and Ford), but I do like several stocks in the auto parts industry. My top pick is Gentherm (THRM), a tier 2 supplier of climate control seats (42% of revenue), heated seats (33%), automotive cables (10%), remote power generation (9%), heated steering wheels (5%) and battery thermal management. Continued strength in global auto sales and production will keep up demand for Gentherm's main products. Guidance for 2016 revenue is up 10% to $941 million. Gentherm's main competitive advantage is its patented thermoelectric device (TED) technology which manages thermal conditions in many of their products. Some of Gentherm's growth opportunities lie in applying their TED technology to new markets such as electric car battery thermal management. Revenue from battery thermal management will kick in 2017 and beyond.
I expect Gentherm to generate close to $150 million in free cash flow in 2016. With an enterprise value of $1.7 billion, the valuation is about 11.7x FCF. I did a comparison between Gentherm, Lear (LEA), Gentex (GNTX) and Delphi (DLPH). Lear has a similar valuation, but it's estimated growth rate is a bit lower. I assume Gentherm has a long term earnings growth rate of 17%, and Lear has a 15% growth rate.
The main risk in this investment is if the auto cycle is at a peak, and global sales and production of autos decline next year. Gentherm's valuation looks cheap, but this is a cyclical stock, so the valuation is bound to look cheap at the peak of the cycle. I do not believe we are at the cycle peak yet. I think China will rebound and the US should power growth for a few more years. If auto sales start to surprise to the downside, this will be a signal to exit this investment.
Michael Grove, CFA