Salvaging for Auto Parts Investment Bargains.

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Author: Stovall, Sam

SAM STOVALL'S SECTOR WATCH

S&P expects the subindustry to remain lackluster, though some improvement may be just around the bend

While wandering through the relative strength charts for the more than 120 subindustry indexes, I came across this rolling 12-month relative price performance chart [pictured below] for the S&P 1500 Auto Parts index. To be sure, there's been plenty of bad news of late for the group, including the bankruptcy filing by Dana Corp. in early March. But the chart indicates to me that the relative beating that this group has taken appears to have subsided.

As a reminder, the jagged blue line represents the sub-industry index's rolling 52-week price performance compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindex's 14-year mean relative strength.

So, of course, my first thought was, "Is it time to buy back into these issues?" I decided to check with Efraim Levy, CFA, S&P's Autos and Auto Parts analyst. In essence, he suggested I continue to let them rust.

S&P's fundamental outlook for domestic auto parts manufacturers is negative. The S&P Auto Parts & Equipment index underperformed the S&P 1500 index in 2005 with a 21.5% decline, vs. a 3.8% rise. Year to date through Mar. 3, the subindex was down an additional 10.8%, vs. a 3.6% increase for the S&P 1500.

HELP FROM STEEL. Levy thinks the group will be hampered by price pressure from manufacturers and higher commodity prices. New products coming from General Motors (GM: sell, $22) and others, and an easing of steel prices should help in 2006, in S&P's view. However, the bankruptcies of Dana and Delphi could put further pressure on parts suppliers.

S&P's outlook for 2006 original equipment sales is modestly negative. Levy sees light vehicle sales volume of about 16.7 million in 2006, down from the nearly 17 million units in 2005. He expects the Big Three to collectively lose share to foreign brands. The greater a supplier's exposure to these domestic companies, in S&P's opinion, the greater the impact.

Levy sees flat to lower European car production in 2006, although production trends should vary by country, which is likely to affect parts manufacturers with European exposure. He projects higher production in Asia, led by China. S&P expects the U.S. automotive parts replacement market to remain lackluster, although Levy thinks demand for new commercial [heavy] trucks will rise again, albeit with more modest increases. Auto makers' demands for price reductions may weigh on suppliers. The analyst believes that rising automobile production in Asia is an opportunity for larger, multinational suppliers to increase sales and profits.

GLOBAL EXPANSION. For the longer term, Levy expects growth opportunities for original equipment manufacturers [OEM] to arise from several sources. First, he sees a rush to add high-tech features to vehicles to distinguish them and to comply with safety and emission regulations. Second, in S&P's view, global expansion is aiding those parts producers that are structuring their businesses to support auto makers' efforts to consolidate designs across their international operations and expand their international businesses. Third, Levy sees an increase in business arising from foreign carmakers setting up production in the U.S.

So there you have it. Maybe the worst is over for this group from a momentum standpoint, and even though the group could experience some unexpected short-term revving-up of share prices, S&P believes the investment outlook for the S&P Auto Parts group is decidedly negative over the coming 12 months. None of the stocks in the group carry S&P's top investment rankings of 4 STARS [buy] or 5 STARS [strong buy]. Lear Corp. (LEA), Arvin Meritor (ARM), Borg Warner (BWA), and Visteon (VC) are among a number of companies ranked 3 STARS [hold].

Source: Standard & Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" [price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Mar. 3, 2006.

Subindustry

Computer & Electronics Retail

Construction & Engineering

Construction Materials

Diversified Metals & Mining

Fertilizers & Agricultural Chemicals

Multi-Sector Holdings

Oil & Gas Equipment & Services

Oil & Gas Refining & Marketing

Railroads

Specialized Finance

Trading Companies & Distributors Water Utilities

Glossary

S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS [STock Appreciation Ranking System], S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark [e.g., a regional index [S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index], based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank [also known as S&P Quality Rank]: Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:

A+            Highest
B             Lower
A             High
C             Lowest
Aâˆ'      Above Average
D             In Reorganization
B+            Average
NR            Not Ranked
Bâˆ'      Below Average

S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity [its creditworthiness] to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.

S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses, and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges, and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard Standard Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore, and Tokyo.

Required Disclosures

In the U.S.

As of Dec. 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.2% of issuers with buy recommendations, 61.3% with hold recommendations, and 10.5% with sell recommendations.

In Europe

As of Dec. 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 33.8% of issuers with buy recommendations, 46.8% with hold recommendations, and 19.4% with sell recommendations.

In Asia

As of Dec. 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 24.8% of issuers with buy recommendations, 53.1% with hold recommendations, and 22.1% with sell recommendations.

Globally

As of Dec. 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 28.7% of issuers with buy recommendations, 59.1% with hold recommendations, and 12.2% with sell recommendations.

• 5-STARS [Strong Buy]: Total return is expected to outperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
• 4-STARS [Buy]: Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
• 3-STARS [Hold]: Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
• 2-STARS [Sell]: Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
• 1-STARS [Strong Sell]: Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index, and in Asia the S&P Asia 50 Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water St., N.Y., N.Y.

Other Disclosures

This report has been prepared and issued by Standard in Hong Kong by Standard in Japan by Standard and in Sweden by Standard & Poor's AB ["S&P AB"].

The research and analytical services performed by SPIAS, S&P LLC, and S&P AB are each conducted separately from any other analytical activity of Standard & Poor's.

Disclaimers

This material is based upon information that Standard & Poor's considers to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy, or adequacy, and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions, and estimates constitute Standard & Poor's judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments, or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price, or income of or from that investment to the investor. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations, or needs and is not intended as a recommendation of particular securities, financial instruments, or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

For residents of Britain: This report is only directed at and should only be relied on by persons outside of Britain or persons who are inside Britain and who have professional experience in matters relating to investments or who are high-net-worth persons, as defined in Article 19[5] or Article 49[2] [a] to [d] of the Financial Services & Markets Act 2000 [Financial Promotion] Order 2001, respectively.

Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations.

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By Sam Stovall