Canadian auto parts stocks a cheap play on improving global supply chain

Canadian auto parts stocks a cheap play on improving global supply chain

You generally want to steer clear of the auto sector when recessionary forces are approaching. This may be the time to break that rule.

Signs of recovery have permeated the industry over the past month as supply chain constraints and shipping bottlenecks have eased up and the global chip shortage has improved.

Auto production is on the rise globally, corporate earnings trends are generally improving across the sector, and the Canadian parts manufacturers, like Magna International Inc. MG-T -1.03%decrease, are seeing their stocks in the early stages of a comeback.

General Motors Co. GM-N even reinstated its dividend this week after a two-year suspension.

The only hitch is that pesky global recession, which is very much a possibility over the next year, according to economic consensus.

Fear not, say some auto sector analysts. Even if demand for new vehicles falters, there will still be an acute need to restock inventories, which remain at historic lows as a result of the supply chain crisis.

“This uniquely positions the auto suppliers and insulates them from a weakening economy,” CIBC World Markets analyst Krista Friesen said in a recent report.

That’s a novel set-up for a sector as attuned to the cycles of the economy as this one. But in this puzzling economic moment, all kinds of well-worn patterns and relationships are falling away.

Clear signs of slowing growth and tightening financial conditions, for example, are contrasting with a booming jobs market, which is helping sustain a hearty appetite for new and used vehicles.

Household finances in North America are, on average, still being propped by a vast amount of excess savings built up over the COVID-19 pandemic. Consumers emerged from lockdown flush with cash and ready to spend.

The auto sector has been unable to fully capitalize on that booming demand. A crippling shortage of semiconductors used in a range of components and sensors meant that automakers had to slash production and make factories idle.

Buyers have faced long delays in receiving new vehicles as dealership lots have emptied out. All sorts of parts became more expensive and tougher to source. “The chip shortage is a perfect example of how just-in-time inventory and single-source supplying became a problem,” said Jason Mann, chief investment officer at Toronto-based EdgeHill Partners. “One component goes down and the whole chain falls apart.”

But the signs of an improving supply backdrop are now starting to pile up. Shipping costs have topped out and the logjam of ships in U.S. harbours seems to have peaked. Indexes measuring global supply chain pressures have fallen by 50 per cent or more. And the auto industry is tracking toward an increase in production of nearly 20 per cent in the second half of this year over the first half.

Crucially, there are no signs that consumers are starting to cut back on spending on new cars.

“While there are growing concerns around a recession, the impact of rising rates and weakening consumer confidence, demand for new vehicles continues to outpace supply,” Ms. Friesen wrote.

As a result, the market has started to reprice the auto sector. Magna’s shares have gained 17 per cent over the past six weeks. Its smaller Canadian competitors in the parts space, Linamar Corp. LNR-T -0.27%decrease and Martinrea International Inc. MRE-T +0.09%increase, have risen by 23 per cent and 42 per cent, respectively, over the same period.

Meanwhile, Edmonton-based auto dealership group AutoCanada Inc. ACQ-T -0.98%decrease has seen its stock advance by 14 per cent since early July, and collision repair chain Boyd Group Services Inc. BYD-T -0.97%decrease by 31 per cent.

That’s a welcome reversal from the sector’s year-long selloff, in which every name in the group lost at least 40 per cent from its peak. That all-consuming slide now has the Canadian auto suppliers trading below their 10-year averages, Ms. Friesen said. Her top picks in the space are Magna, Linamar and AutoCanada.

The major hit to demand that investors have feared could still materialize, particularly if North American unemployment starts to rise meaningfully.

But even if that happens, these stocks will have the support of low valuations as well as depleted inventories across the entire industry, Ms. Friesen said.

“There will still be a need to replenish inventory levels, which we estimate could take until at least 2024.”






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