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(Adrian Wyld/Adrian Wyld/The Canadian Press)
(Adrian Wyld/Adrian Wyld/The Canadian Press)

Why auto parts stocks appear set for gains Add to ...

American junkyards are filling with millions of worn-out cars, and consumers will have to replace them sooner or later.

That bodes very well for major Canadian auto parts makers, whose shares have largely stagnated in recent months after a year of furious growth.

Analysts say the stocks look set to push ahead in coming years, making them a good play for patient investors.

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Canada's three biggest parts suppliers - Magna International Inc., Linamar Corp. , and Martinrea International - have demographics working in their favour, they argue.

U.S. light vehicle sales haven't kept up with the annual scrappage rate of 12.5 million vehicles. But the population is still growing and people still need to get to work and school.

"Any Canadian auto parts supplier that's tied to North American light vehicle production is going to see explosive earnings growth in the next couple of years," said Morningstar analyst David Whiston.

"Last year was the first year we scrapped more than we sold since at least World War II ... I don't think that's sustainable when the number of licensed drivers in the United States increases by 1 per cent every year. Also, you've got vehicle fleets getting to all-time highs age-wise."

Mr. Whiston is keen on Canada's parts makers because they're profitable even with U.S. auto sales near historical lows.

A year and a half ago, the automotive sector was at the bottom of one of the most devastating downturns in its history. General Motors Co. and Chrysler - major customers of all three of Canada's big parts makers - were both in trouble.

As the industry pulled back from the brink, Magna's share price rose about 2-1/2 times. Linamar surged tenfold, and Martinrea jumped about fourfold.

Fears of a stalling U.S. recovery have slowed the shares since then. Jobs data Friday showed the U.S. economy shed jobs in September for a fourth straight month. Unemployment is stubbornly high at 9.6 per cent.

But analysts say as bad as the headlines are, people can't keep driving the same cars indefinitely.

"To earn a living, pay your mortgage and everything else, you need transportation," said Marvin Wolff, an analyst at Paradigm Capital in Toronto,

"You get to the point where you must replace your car because it's a necessity, not a luxury. I think we're going to have that catch-up for sure."

U.S. auto sales came in at just over 10 million vehicles in 2009. Experts expect about 11.5 million to be sold this year. That's a far cry from 1999 to 2007, when sales topped 16 million a year and peaked at more than 17 million.

Mr. Whiston said he thinks sales will eventually get back into the 16 to 17 million range and there will probably be a year above that "just because there is so much pent-up demand."

He thinks Aurora, Ontario-based Magna is well positioned to profit from an upswing. His Magna price target is $98 (U.S.).

Paradigm Capital's Mr. Wolff said he's "very, very encouraged" by the fact that GM, the biggest of the U.S. auto makers, got back into the credit game with the purchase of AmeriCredit Corp . It shed its GMAC unit during the crisis.

"The fact that you have not been able to get easy financing of a car has definitely hurt the car market," he said.

He sees sales benefiting now that GM customers can get leases and loans at the dealership without the hassle of looking elsewhere for cash. The resulting annual sales increase could be 750,000 to 1.25 million cars a year, he said.

Mr. Wolff, whose 12-month price target for Martinrea is $13 (Canadian), said he likes the stock's potential because it is cheap relative to its peers.

"If you look at any of the consensus numbers, Linamar and Magna are trading at 9.5 times 2011 EPS estimates," he said, referring to next year's estimated earnings per share. "In Martinrea's case, they are trading at 7.5 times my EPS estimate for 2011."

Still, not everyone is convinced Canadian auto shares are a wise investment. Veteran industry consultant Dennis DesRosiers noted Canadian parts makers are some of the world's best managed and have upside sales potential as the sector rebounds.

"Now, whether that translates into an increase in their share prices is a different story, because that doesn't necessarily mean that share prices go up -- the logic says they will, but the stock market is a very strange beast," he said.

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