2 Auto Replacement Parts Stocks Making Strides Against Odds

The transition toward electric and self-driving vehicles has necessitated a strategic realignment of business models for participants in the Zacks Automotive Replacement Parts industry. To capitalize on evolving market dynamics, companies must formulate a comprehensive roadmap that maximizes the available opportunities. Balancing high operational costs is crucial, prompting industry players to focus on the cost-effective development of parts and components to maintain their market share.High raw material expenses, unfavorable foreign exchange translations and logistical hurdles are adversely impacting profit margins. However, amidst these challenges, the increasing longevity of vehicles offers a glimmer of hope. In this challenging landscape, Genuine Parts Company GPC and LKQ Corporation LKQ stand out favorably due to their strategic acquisitions and investor-friendly initiatives.

Industry Overview

The Zacks Automotive - Replacement Parts industry comprises companies that engage in the production, marketing and distribution of replacement components for the automotive aftermarket. The industry players offer replacement systems, components, equipment and parts to repair as well as accessorize vehicles. Some important auto replacement components are engine, steering, drive axle, suspension, brakes and gearbox parts. The auto replacement market is somewhat less exposed to business downturns as consumers are more inclined to spend on replacement parts to maintain their vehicles rather than splurge on new ones. Consumers can either opt for repairing vehicles on their own or can avail professional services for the same. The industry is undergoing a radical change, with evolving customer expectations and technological innovation acting as game changers.

Key Themes at Play

Aging Cars Creating Opportunities: A recent S&P Global Mobility report reveals that a combination of limited supply and escalating prices is causing a decline in Americans' interest in purchasing new cars. The average age of vehicles in the United States has reached 12.5 years, indicating an increase of three months compared to the previous year and reaching an all-time high. This prolonged lifespan of vehicles is playing a significant role in driving demand for auto replacement and repair companies. To ensure the continued functionality of their aging vehicles, customers are choosing to invest in replacing faulty parts and components. As a result, there has been a noticeable surge in demand for auto replacement parts. Additionally, due to concerns about an economic slowdown, customers are anticipated to prefer repairing their older vehicles instead of spending excessive amounts on new, high-priced vehicles.

Mounting Costs of Technological Advancements: The surging popularity of electric vehicles has compelled the industry to invest heavily in the development of technologically advanced auto components. However, these high technology costs are posing a significant challenge to the margins of auto replacement parts. As the industry strives to keep up with the evolving trends and demands of the automotive market, companies are required to continuously develop and upgrade their offerings. This necessitates substantial capital expenditure and research and development expenses. Consequently, the burden of these costs is likely to exert pressure on operating margins and cash flows within the industry.

Commodity Pressures & Forex Woes Squeeze Margins: The auto replacement parts industry is facing significant challenges as high raw material prices, particularly steel and non-ferrous metals, are putting a strain on gross margins. The inflation of commodities adds further hurdles and is expected to persist for a considerable period, hindering profitability. Moreover, the global presence of most industry players makes them susceptible to foreign exchange difficulties. Unfavorable currency translations are likely to impact earnings and margins negatively. Furthermore, the industry is grappling with logistical obstacles and disruptions in the supply chain systems, which further cloud the industry's outlook and prospects.

Zacks Industry Rank Signals Dim Prospects

The Zacks Automotive – Replacements Parts industry is a seven-stock group within the broader Zacks Auto-Tires-Trucks sector. The industry currently carries a Zacks Industry Rank #184, which places it in the bottom 27% of around 250 Zacks industries.

The group's Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry's positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's earnings growth potential. Over the past year, the industry's earnings estimates for 2023 have moved 3% south.

Despite the industry's muted near-term outlook, we will present two stocks worth considering for your portfolio. But before that, let's take a look at the industry's stock market performance and current valuation.

Industry Outperforms Sector but Lags S&P 500

The Zacks Automotive – Replacement Parts industry has outpaced the Auto, Tires and Truck sector but underperformed the Zacks S&P 500 composite over the past year. The industry has declined 3.4%, narrower than the sector's loss of 25%. Meanwhile, the S&P 500 has risen 1.7% over the same timeframe.

Industry's Current Valuation

Since automotive companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. On the basis of trailing 12-month enterprise value to EBITDA (EV/EBITDA), the industry is currently trading at 8.15X compared with the S&P 500's 12.74X and the sector's trailing-12-month EV/EBITDA of 11.72X. Over the past five years, the industry has traded as high as 15.08X, as low as 6.76X and at a median of 9.44X, as the chart below shows.

2 Stocks Worth Considering

Genuine Parts: Atlanta-based Genuine Parts distributes auto and industrial replacement parts across the United States, Canada, Mexico, Australia, New Zealand, Singapore, Indonesia, France, the United Kingdom, Germany and Poland. The acquisitions of PartsPoint and Alliance Automotive Group and the possession of full ownership in Inenco have bolstered the company's growth. The KDG acquisition has strengthened Genuine Parts’ market-leading position on the North American industrial platform. The company's dividend aristocrat status boosts investors’ confidence. Genuine Parts approved a $3.88 per share annual dividend for 2023, representing its 67th consecutive annual increase in the dividend.

The Zacks Consensus Estimate for GPC's 2023 and 2024 sales implies year-over-year growth of 5.8% and 4.2%, respectively. The consensus mark for 2023 and 2024 earnings suggests a year-over-year improvement of 8.6% and 7.5%, respectively. Genuine Parts — currently carrying a Zacks Rank #2 (Buy) and a Value Score of A — topped earnings estimates in the trailing four quarters, with the average surprise being 8.2%.

You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

LKQ: Headquartered in Illinois, LKQ is one of the leading providers of replacement parts, components and systems. The buyouts of Elite Electronics, Green Bean Battery, SeaWide Marine Distribution, Greenlight and Fabtech Industries have bolstered the firm's product offerings and sales. LKQ's focus on cost discipline and simplification of its operating model are likely to result in sustained margin expansion. Low leverage and high liquidity are other positives that aid margins. LKQ has investment-grade ratings from all three major rating agencies. We like the company's commitment to increasing shareholder value.

The Zacks Consensus Estimate for LKQ's 2023 and 2024 sales implies year-over-year growth of 4% and 5.5%, respectively. The consensus mark for 2023 and 2024 earnings suggests a year-over-year improvement of 6% and 8%, respectively. LKQ— currently carrying a Zacks Rank #3 (Hold) and has a Value Score of A — topped earnings estimates in three of the trailing four quarters and missed on the other, with the average surprise being 2.5%.

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