MILLBURN, N.J. (Stockpickr) -- It all happened in 2008: The price of crude oil shot up to nearly $150 dollars a barrel, and auto sales plummeted. The key takeaway from this systemic event was the historical change in the way people looked at automobiles and the way automakers built them.Then a second shock hit the global economy: a credit crisis. Credit availability tightened. Consumers used to purchasing or leasing cars on attractive terms could no longer do so. These economic events took a lot of wind out of the auto manufacturer's sails and placed a lot of money on the sideline. And, for a very good reason; sales are the backbone of the auto industry. For example, let's take a look at one of the most crucial numbers in the auto industry, the seasonally adjusted annual rate of U.S. light vehicle auto sales. Way back in 2006, the figure was around 16 million to 17 million units sold per year. This continued until the first quarter in 2008, when there was a notable shakeup, and demand slid. As the price of oil continued to ratchet up and credit dried up, auto sales continued their downward spiral. In turn, the industry witnessed as the ill-prepared companies -- Chrysler, Ford ( F - Get Report), General Motors -- experienced tremendous demand destruction due to their product mix, which was heavily weighted toward gas-guzzling pick-up trucks and large sport-utility vehicles. While these domestic manufacturers were bringing large amounts of revenue during the good times, thanks to large profit margins on trucks and SUVs, they were rattled to their core in the bad times. Because of this huge hit on their sales figures, the ripple effect spread to key suppliers for the American auto builders. Take, for example, American Axle ( AXL - Get Report), which provides a substantial amount of driveline components to General Motors for its light trucks and SUVs. According to American Axle's most recent 10-K, GM accounted for 78% of total net sales in 2009. So it is no surprise that a stock that was trading around $20 in the beginning of second-quarter 2008 wound up trading for as low as 40 cents by April 2009. Now the stock has made a substantial recovery and closed Thursday at $11.38.
Eventually, the numbers reached the trough in 2009 and were artificially raised in July and August 2009 thanks to the federal government's Cash for Clunkers program as well as year-end model-year specials and availability of financing indirectly sourced by lenders through other government programs such as the Troubled Asset Relief Program. Currently, the SAAR figures are expected to fluctuate depending on incentive programs. For example, March 2010 was a month full of incentives but only managed to scrape up a SAAR of 11.8 million, a disappointment for many analysts who were forecasting 12 million or more. To put that in perspective, it's akin to missing an EPS estimate. Granted, March was a vast improvement over the past two months, which had been on a gradual decline. With that said, the worst appears to be behind us for the automotive industry, and now looks like a good time to get involved. Sales are beginning to pick up, and the companies that were ill-prepared have done an about-face. But don't rush to put in your longs and shorts without first doing your homework. While the industry appears to be on the upswing, there still are many risks. In this two-part series, we'll take a closer look into the industry -- and in the process sort out the clunkers from the dream machines. Auto Part Suppliers Since we are looking at the automotive supply chain, let's take it from the top: the suppliers. Automakers do produce some of their product in-house, but as costs continue to increase, there is a growing concern to minimize any outgoing cash flow. The solution to keeping R&D and manufacturing costs lean is to have a go-to parts supplier that can get the job done with solid expertise. There are huge costs involved when having to hire teams of experts to produce only one part when there are thousands working in tandem. Cars and trucks have become so technologically advanced that it has been said that autos are now more complex than airplanes. Think of all the systems and computers controlling a vehicle these days. It is maddening. As technology makes leaps and bounds, a vehicle's complexity will only grow.
Make sure to do thorough due diligence on an auto supplier before becoming vested. Each company is unique in its specialties and targets different markets. Additionally, a large firm such as Johnson Controls ( JCI - Get Report) has several different business sectors not related to automobiles. Need help? Other than the usual investment sources, the best places to find these details are the firm's Web site, annual reports and quarterly reports. TRW ( TRW) is a perfect example of an automotive supplier that is specialized in high-tech solutions, with 85% of their sales coming from major original equipment manufacturers (the automakers). Furthermore, TRW generates nearly 60% of its sales in Europe. Its forward P/E ratio is low at 11.66, which makes it more of a value play in contrast to its competitors. Additionally, the company has made a monumental comeback from March 2009, when it was trading under $2 bucks. Although I wish the stock had more exposure in the North American and Asian markets, I do like this company. Just exercise some patience and wait for it to pull back about 15% before going long. Parts Retailers & Service The last players in the auto world are the parts retailers and companies that cater toward servicing vehicles. Remember, with downbeat consumer confidence, high unemployment and cash-strapped consumers, many vehicle owners will turn to fixing their autos rather than replacing them with new ones. Unlike the dealers, parts retailers and service companies are able to dodge slower sales figures because they are largely focused on cars that are more than seven years old. Keep in that the automobile's material quality has improved substantially over the years, so buyers are more likely to hold on to a vehicle that has weathered the test of time. Conversely, with the price of crude trending upward since the beginning of 2009, we can assume the price of gas at the pump will also increase steadily. In turn, cash-strapped auto owners will likely begin to drive less or trade up to vehicles with better miles-per-gallon figures. With new rules stipulating a 35.5 industry average by 2016, we can expect compelling new products that obtain lofty MPG numbers.
One company managing to continuously produce is AutoZone ( AZO). Its management is stellar, religiously posting solid gains and double-digit EPS growth. The firm is exposed to a wide variety of products on their shelves, so they are not catering to one particular audience. AutoZone has a low P/E ratio relative to its competitors and has had a strong past 52 weeks. Stay tuned for part 2 of this series, in which we'll discuss the auto manufacturers and retailers. -- Written by Scott Rothbort in Millburn, N.J. Note: Contributing to the research and writing of this report was Richard Posluszny. Posluszny is a graduate of Seton Hall University's Stillman School of Business and is currently a contributing editor at AutoSpies.com and an associate producer for Auto Stream's Fast Lane Daily.