Despite continued trouble in Europe, the auto supply sector has been outpacing the broader market averages over the past year, as it rides higher auto production in North American and Asian markets.According to the North American Auto Dealers Association (NADA), domestic auto sales were running at an annualized rate of 15.5 million for the first eight months of 2013, an 8.9% gain over the prior year period.Legendary investor Carl Icahn’s investment vehicle of choice in the sector is Federal-Mogul Corp (NASDAQ:FDML), whose shares perked up nearly 30% in July on the back of a pickup in sales growth and higher profitability in its second quarter of FY2013.Should investors follow his lead?
What’s the value?
Federal-Mogul produces a diverse variety of parts for vehicles, including leading positions with its Wagner braking and Moog suspension product brands.The company has a wide operating footprint of 94 manufacturing facilities across 34 countries, which allows it to provide parts for all of the major auto manufacturers, regardless of where the companies choose to domicile their plants.However, Federal-Mogul has been shrinking its plant capacity lately as it exits non-core product areas, with current plans to close or sell fourteen plants.
Despite the positive surprise in its second quarter results, Federal-Mogul’s increase in sales for the FY2013 year-to-date period has been less impressive, with a 1.6% gain over the prior-year period.Its top-line growth has been capped by weak auto sales in its large European segment, an area that accounts for roughly 43% of its overall sales.In addition, Federal-Mogul’s gross margin was hurt by a lower market share for diesel-based vehicles in the European market, an area that generates a higher margin for the company’s related products.
Moving toward systems
While Federal-Mogul’s recent rights offering of $500 million will improve its leveraged financial position, its current operations aren’t providing the cash flow necessary to fund its annual capital expenditure programs.The company likely needs to move into providing more system products rather than individual components, a strategy that has worked well for larger competitors, like TRW Automotive Holdings Corp. (NYSE:TRW) and Johnson Controls, Inc. (NYSE:JCI).
TRW has placed its bets on safety systems for vehicles, an area that generates roughly 89% of its overall sales.The company has benefited from a greater focus on vehicle safety by the National Highway Transportation Safety Administration (NHTSA), including its 2011 mandate for vehicles to have electronic stability controls, which are capable of taking over braking in critical situations.
In FY 2013, TRW has found growth hard to come by, with a 3.3% increase in revenues versus the prior-year period.Like Federal-Mogul, TRW’s large exposure to the relatively weak European market, accounting for roughly 49% of sales, has limited its top-line growth.