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Why You Should Sell Delphi and Buy GM

PAULSON & COShares of Delphi Automotive PLC (DLPH) have been on a tear this year.  After opening 2012 at $22.11 per share, shares are now trading hands ~44% higher for the year at $32.00.  DLPH, a leading global vehicle component manufacturer providing electrical and electronic powertrain, safety and thermal technology solutions to the global automotive and commercial vehicle markets, has seen its shares soar after the company’s reemergence from bankruptcy protection and subsequent IPO in November 2011 which came public at $22/share. Billionaire hedge fund managers John Paulson, Paul Singer, Howard Marks, and David Einhorn had large positions in the stock at the end of December.

Full year 2011 revenue came in at $16 billion, growing 16.1% over 2010 results as auto production began to pickup toward prior levels.  Fourth quarter earnings per share came in at $.88 compared to analyst consensus estimates of $.56/share for the period.  The company’s President and CEO, Rodney O’Neal, attributed the operating success to DLPH’s robust business model, operational excellence and industry-leading cost structure.

Revenue guidance for 2012 though was a little disappointing, coming in at a range of $16.2 to $16.5 billion.  Although this still projects growth in the 1-3% range, it put analysts’ then current forecasts of $16.45B near the top end of that range.

Component companies face significant challenges over the next few years in North America as demand has waned in recent years evidenced by a 2% annualized drop in production volume from Detroit’s Big 3 manufacturers over the prior ten year period while increased competition from international based component manufacturers is also expected to keep pressure on margins going forward.  Auto manufacturers expect the majority of future growth to come from sales of autos internationally especially in markets like China. Both General Motors (GM) and Ford (F) saw sales gains from China in 2011 with growth of 8.3% and 7% respectively.

Time will tell if this is an important sign, but it seems at least one legendary investor has his doubts on this continued success and is using every opportunity to lighten his load.  John Paulson reported holding 51.7 million DLPH shares or 15.8% of the company as of December 31, 2011.  His funds had previously owned 22% of the company prior to sales completed during the IPO process.

Mr. Paulson recently took advantage of another opportunity to sell shares. In several transactions Paulson sold 4.4 million shares of Delphi between March 5th and March 14th. This brought his holdings down to ~47.3 million shares.

A look at price performance of DLPH peers, TRW Automotive (TRW) which is up ~114% YTD,  Autoliv (ALV) up ~25% YTD and Magna International (MGA) up ~43% YTD  provides proof that the entire group has performed fairly well versus the SP500’s 10.5% YTD return thus far.  On a valuation basis, DLPH’s forward P/E of 8.77 is mostly inline to favorable when compared to TRW, ALV and MGA which come in at 7.97, 10.78 and 10.50 respectively. The price/sales ratio at 1.99 for DLPH also compares nicely to peers with TRW at 2.92, ALV at 8.37 and MGA coming in at 1.69.  Ratio comparisons here provide no apparent red flags; however, given the continued longer term pressure on North American auto sales, growing competition from international based component manufacturers and Mr. Paulson’s apparent desire to significantly reduce his holdings, it may be time for investors to reassess their faith in holding shares of DLPH.

We believe auto manufacturers are better bets than parts manufacturers. They are both cheaper and the auto demand over the next couple of years will be more favorable to auto companies. GM’s forward PE ratio is at least 20% lower than the parts manufacturers we discussed. Ford is 20% more expensive than GM but still cheaper. Consumers have been postponing their purchases since the 2008-2009 crisis. We believe demand for automobiles will be stronger than expected in 2012 as low interest rates and pent up demand will lift auto sales to 15 million units. We also expect this trend to continue in 2013. GM is still trading at 25% discount to its IPO price and investors are deterred by federal government’s large stake in the company, but we believe this is the right time for long-term investors.

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