3 Post-Bankruptcy Auto Supplier Stocks for 2011

(Auto-supplier bankruptcy story updated with end-of-the-year figures, Fitch Ratings forecasts and GM chart.)

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NEW YORK ( TheStreet) -- Over the last two years, the strongest auto suppliers have managed to claw their way out of the auto industry meltdown to live another day in 2011.

According to the Original Equipment Suppliers Association (OESA), the number of auto suppliers who have filed for bankruptcy has shrunk to five in 2010 from 62 in 2009, as major customers such as General Motors ( GM) and Chrysler resurfaced from bankruptcy protection. "We continue to see an environment where the strong suppliers will get stronger, while weak firms will eventually exit the industry or be acquired," Morningstar analyst David Whiston said in a note. "There is more hope of higher production volumes than the last time we looked at the sector."

According to OESA, auto suppliers comprise the largest manufacturing sector in the U.S.

Results of a November survey on auto supplier sentiment by OESA indicate that suppliers are becoming more optimistic overall about the business environment. Readings rose to 61 in November from 52 in September as responses shifted significantly to "unchanged" and "somewhat more optimistic." Noteworthy was that the smaller companies saw a greater increase in optimism than the larger ones.

Market research firm IBISWorld says suppliers focusing on auto climate control, electronics and seating may do particularly well 2011 due to increasing demand for luxury interiors, entertainment and navigation systems, and electric-powered vehicles. Meanwhile, KeyBanc Capital Markets believes that auto companies at the Detroit Auto Show on Jan. 11 and 12 will likely tell investors that production in the fourth quarter of 2010 exceeded both the expectations of the companies themselves and those of equity analysts.

UBS analyst Colin Langan says to expect more supplier merger and acquisition deals over the next three years as the economy continues to recover, especially given that they have "plenty of dry powder." Currently their cash levels are at nearly 20% proportional to total, industry-wide market capitalization, says Langan.

At least eight global auto industry deals were completed in the last 12 months as suppliers sought to buy growth at the bottom of the economic cycle; recent deals went for less than 10% of sales, Langan noted.

Fitch Ratings reports that that though auto demand in 2011 should be greater than that of 2010, sales growth will be uneven across regions, with demand growth in the U.S. and developing markets offsetting continued declines in Europe. Fitch Ratings says that even in the U.S., light vehicle sales in 2011 could remain "well below" pre-recession levels.

Fitch projects that U.S. light vehicle sales will reach 12.5 million units in 2011, up 9% from the 11.5 million seasonallybadjusted annual sales rate seen for the year-to-date through Nov. 30, 2010, but doesn't expect light vehicle sales volume to breach a 15-million-unit level for at least two years, which would still be roughly 2 million units below the peak level seen before the recession.

As the competitive nature of the auto industry world heats up again and rivalries grow fiercer, we take a look at how three auto suppliers -- all of whom have been symbolic of the auto industry rebound story -- will cope in 2011. Two of them have emerged fresh from bankruptcy, while the third -- while managing to skirt bankruptcy, has been rising impressively on GM's comeback, but may face headwinds in 2011.

Read on for a 2011 performance preview of three auto suppliers....

Visteon ( VSTOV ) (Part 1)

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Freshly emerged from bankruptcy protection on Oct. 1, 2010, Visteon now has a balance sheet that IBISWorld analyst Casey Thormahlen describes as "pretty" and "admirable."

Looking into 2011, Thormahlen said, "expect them to do well."

David Silver from Wall Street Strategies says Visteon had a much tougher time in bankruptcy protection than Lear ( LEA), another auto supplier that filed for Chapter 11 last year, and any of the auto makers that went in bankruptcy protection. But now, Van Buren Township, Mich.-based Visteon is in a better place and "should be improving." Visteon filed for Chapter 11 bankruptcy protection on May 28, 2009.

During bankruptcy protection, Visteon sold off many of its divisions and is now focused on its core, niche specialties: climate control, interiors and electronics. This leaner operation makes the company less prone to debt burden, ratings downgrades and onerous interest expenses -- and makes profits easier to come by. Another advantage that Visteon has as it's coming out of bankruptcy protection is strong ties with two of the fastest growing auto brands in the world: Hyundai-Kia and Ford ( F); the majority of its revenue comes from these two brands. Visteon was a division of Ford, but was spun off from the automaker a decade ago.

Some 83% of Visteon's revenue now comes from outside of the U.S., with more than 42% of it coming from the fast-growing markets of Asia.

"One of the biggest positives from the latest earnings release for Visteon was the operating cash flow," Silver said. The company generated $50 million of cash flow from operations, which Silver said helped "remodel" its balance sheet. "Operations are improving."

CRT analyst Kirk Ludtke was encouraged by the equity income of $35 million generated by the company's unconsolidated joint ventures in the third quarter -- far better than the $23 million he had expected. Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) increased 16% from the year before -- albeit on essentially flat sales.

"It's the fact that sales were flat that concerns us," Silver said.

In all, for the third quarter ended Sept. 30, Visteon reported net loss of $140 million, or $1.08 a share vs. net loss of $38 million, or 29 cents a share the year before. Net sales came out to be $1.73 billion, more or less unchanged from a year ago.

Visteon ( VSTOV ) (Part 2)

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Despite Visteon's impressive improvements and high-profile customer base, neither Thormahlen nor Silver are expecting the company to accelerate at full speed ahead. "Expect them to do well," Thormahlen says of Visteon, post-bankruptcy, "but they will be different. You can't compare them to their past performance;" in unloading a bulk of its assets during bankruptcy reorganization, the company also reduced its diverseness, which translated into less revenue potential.

Over the years, Visteon has shrunk to a company of less than $10 billion a year from nearly $20 billion. In the 12 months ended Sept. 30, it had sales of about $6.7 billion. The company currently has a presence in 26 countries and 26,500 employees.

Subsequent to its reorganization, Moody's assigns a B1 corporate family rating to the company with the expectation that Visteon's more modest debt burden following Chapter 11 emergence will be adequately supported by its earnings and cash flow growth. The rating agency has a stable outlook for the company. But the rating also factors in risks such as Visteon's ability to access funds generated by its foreign subsidiaries and joint ventures, efficiently and inexpensively.

Standard & Poor's, for its part, has assigned a B+ corporate credit rating on Visteon with stable outlook. With the company currently mainly owned by former creditors, "we believe the company's financial and strategic policies could evolve over time," S&P analysts Robert Schulz and Nancy Messer noted in a recent report. Still, the report notes, "we view Visteon's financial risk profile as aggressive, largely because we assume the company will use cash in 2011 for increased capital spending and cash restructuring. Also, we believe acquisitions or possible future distributions to shareholders could absorb free cash flow and constrain significant debt reduction in the long term."

Typically, companies that receive ratings in the range of Aaa to Baa3 are considered to be investment grade, while those that receive assessments in the range of Ba1 to C are considered to be high-yield or non-investment grade or "junk."

As Visteon moves forward, post-bankruptcy, Langan from UBS sees a potential M&A combination between Johnson Controls ( JCI)and Visteon and Valeo and Visteon. In a report, Langan says that Johnson Controls has investment-grade balance sheet and would be able to finance such a transaction. Visteon's interiors and electronics division would be especially beneficial to Johnson Controls; however, Visteon has rejected its advances in the past.

Valeo would find Visteon attractive for its climate control division. Valeo's ability to finance a transaction would in part depend on further rate hikes by credit rating agencies.

Lear ( LEA) (Part 1)

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Lear has been a source of great enthusiasm for analysts.

IBISWorld's Thormahlen believes that the company's decision to go through Chapter 11 was a "shrewd" business decision.

"No one faulted them for going through with it," Thormahlen says, even though the company didn't have the obvious solvency issues faced by other Chapter 11 graduates such as GM, Chrysler and Visteon. Still, Thormahlen says, since basically everyone else was going through it, too, the company had what might be viewed as a "free pass" to go through it as well; management made sure it took that free pass.

"They walked out cutting their debt in half," Thormahlen says. What's more, unlike peer Visteon, it remained diversified and therefore not completely reliant on a single or small group of customers -- though its exposure to the Detroit Three remains large.

Southfield, Mich.-based Lear filed for Chapter 11 bankruptcy protection on Jul. 7, 2009 and emerged with an enviable balance sheet on Nov. 9, 2009. Since then, it has received a number of corporate upgrades, which makes funding its debt easier. "Lear has been a monster since it became a publicly-traded company again," says Wall Street Strategies' Silver. With net sales of $9.7 billion in 2009 and about 75,000 employees in 35 countries, Lear's businesses primarily comprise of seating systems, electronics and electrical systems.

Silver likes auto suppliers such as BorgWarner ( BWA), Magna International ( MGA) and Johnson Controls for their push for fuel efficiency, but posits that there is "a strong future for the likes of Lear;" a big part of Lear's business is in electronics in a time when interactive electronics increasingly become a major selling point for consumers.

Nevertheless, Silver says he's a bit worried about Lear's revenue being concentrated in North America and Europe. He's expecting the Europe market to be relatively weak next year and growth in North America to slow. "Around the globe, production was up 13% during the third quarter and I do not think that is sustainable," he said of the company.

Lear ( LEA) (Part 2)

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For the third quarter ended Oct. 2, Lear reported an almost tripling of net income to $95.3 million, or $1.76 a share, from $24.6 million, or 32 cents a share a year ago. Adjusted earnings per share was $2.28, far exceeding the analyst consensus of 95 cents a share. Net sales increased more than 10% to $2.8 billion, from net sales of $2.5 billion a year ago.

Citi analyst Itay Michaeli tells clients that he thinks Lear's multiples have been depressed following its 2009 financial restructuring, and that there's room for multiple expansion with earnings production and earnings recovery in the U.S. in 2010 and 2011, and as more "traditional" equity investors come back to Lear.

Stephanie Link, director of research for TheStreet, thinks Lear has one of the most compelling stories in the auto supplier group. Link says the company's healthy balance sheet could lead to a large buyback program of about $1 billion in size in early 2011.

The company current holds a number two position in the $45 billion to $50 billion global automotive seating market. Barclays analyst Brian Johnson expects "modest" earnings growth in 2011 based on "flattish" production in North America and Europe and benefits from $1 billion in new business and exposure to growth in the emerging markets -- offset by large production decline in GM's GMT900 trucks -- an area that Lear supplies.

Currently Moody's has a Ba3 corporate family rating with positive outlook for Lear. Moody's analysts Timothy Harrod and Michael Mulvaney tell investors that they expect Lear to continue to benefit from the gradual recovery of the auto industry in the intermediate term. "However, Lear will continue to be faced with the challenges of high customer concentrations to the Detroit-3" and Europe, they predict. In 2009, 36% of the company's net sales were attributable to GM and Ford, and about 47% of net sales were attributable to Europe. Moody's expects 2011 European demand may be "adversely impacted" by government austerity measures.

Looking at M&A combinations involving Lear, Langan from UBS thinks that its seating division would be good for Magna and that Magna is in a good position to finance a deal. In 2007, Lear's management favored leveraged buyouts said Langan; management's equity would vest immediately upon sale, he explained. He also sees that Lear's seating division could be attractive to Faurecia; however, to finance a deal, the latter would probably require significant equity.

As with Magna, Lear may be willing to accept courtship from Faurecia, says Langan. Finally, he believes that Lear may find Leoni's auto electrical division attractive and says it has the cash to go through with an acquisition. However, Leoni trades at a premium to Lear, so the latter may meet some resistance from the former.

Langan says that Lear has been performing very well since its emergence from bankruptcy, for about a year now, and doesn't see significant risk in 2011 from the company's GM exposure.

American Axle & Manufacturing's ( AXL) (Part 1)

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Today, analysts aren't seeing any other major, publicly-traded auto supplier on the brink of bankruptcy, but there have been concerns about American Axle & Manufacturing's heavy dependence on GM as a customer. Although American Axle managed to avoid entering bankruptcy during the past two years, it still struggled along with the rest of the sector.

"If GM's production does fall off another cliff, I think that AXL would be in extreme danger," says Silver. "The company has made great strides over the past year, but is so dependent on GM sales that another collapse would also certainly spell disaster."

Sales to GM were about 78% of American Axle's total net sales in 2009, 74% in 2008 and 78% in 2007. Some 8% of revenue came from Chrysler in 2009.

Detroit, Mich.-based American Axle manufactures, engineers, designs and validates driveline and drivetrain systems and related components and chassis modules for light trucks, sport utility vehicles (SUVs), passenger cars, crossover vehicles and commercial vehicles. It operates in 13 countries and has about 6,500 employees.

Thormahlen says "it's a little harder to get excited about American Axle compared to Visteon and Lear" because its balance sheet is not as shiny as the other two -- there hasn't been much significant change there over last two years -- and it's tied to a lower-growth company. Like Silver, this analyst cites American Axle's "inherent volatility risk" due to its dependency on GM, which sharply boosted the company's growth in 2010. "I don't think GM will outpace Hyundai or Volkswagen ( VLKAY ) any time soon revenue-wise. GM's sales figures have been doing well, but the others are still outpacing them every quarter."

American Axle & Manufacturing ( AXL) (Part 2)

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For the third quarter ended Sept. 30, American Axle reported a nearly doubling of net earnings to $38.8 million or 52 cents a share, from $19.6 million or 35 cents a share a year ago, far exceeding the 39 cents that Wall Street was calling for. Net sales rose about 51% to $618.2 million, from $409.6 million, beating the analyst consensus expectation of $570.1 million. Stellar results were driven by strong GMT900 truck production by GM. Johnson from Barclays says in general, better GMT900 production is expected for 2011.

Moody's has a B2 corporate family rating with stable outlook for American Axle. Moody's says the company's operating performance has improved over the past two quarters and believes that this can be sustained in the intermediate term due to stable auto production in North America and cost structure improvements the company completed in 2009. However, the company is largely exposed to SUVs and light trucks at time a time when consumers are becoming increasingly interested in smaller cars at least in the intermediate term.

After participating at the company's recent annual dinner for sell-side analysts in New York, Credit Suisse analyst Christopher Ceraso tells clients that the company has a compelling story to tell, but could be facing a more challenging 2011. While American Axle reports the gross figure of $850 million in new business backlog over the next three years, widening customer diversification and a stronger balance sheet, Ceraso thinks risks outweigh rewards in the near term; noting also that benefits from new business don't really kick in until 2012.

Ceraso says unless there's surge in customer demand, American Axle faces difficult comparisons for vehicle production in 2011 given that its primary customer restocked inventory in 2010.

Ceraso notes that furthermore, American Axle's costs will rise in 2011 in connection with a financing agreement struck earlier. The agreement requires the company to undo what were favorable working capital payment terms, resulting in cash outflow of about 150 million in 2011. The agreement also reduces the company's ability to pass on metals costs as it introduces "price-downs," or costs reductions, for automotive OEM customers for the first time in years. Recently, U.S. automakers have been demanding price cuts from their suppliers as the automakers compete for better margins in a tough competitive environment.
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-- Written by Andrea Tse in New York.

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