This Sector Has Power and Traction

07/13/2011 8:30 am EST


Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

Pockets of the automotive sector look very good going into the second half of the year, writes Taesik Yoon of Forbes Growth Investor.

As for my outlook on the second half, I think the outperformance in large-cap stocks seen in the first half will wane as they become more richly valued.

Conversely, I expect to see better performance from high-quality, mid- and smaller-cap shares, as more investors focus on value. I also see the trend of investors favoring non-cyclical industries and dividend-paying stocks continuing for the remainder of the year.

Cummins Inc. (CMI) is a leading global manufacturer of diesel and natural-gas engines, engine-related component products, and electric power generation systems.

Its Engine segment (49% of net sales in 2010) produces a wide range of engines that run on diesel and natural gas used in heavy-, medium-, and light-duty trucks, buses, automobiles, RVs, and industrial vehicles. These engines range from 60 to 3,500 horsepower.

The company’s Components segment (19% of 2010 sales) makes and supplies filtration products, exhaust aftertreatment solutions, fuel systems, controls, and air-handling systems. CMI also manufactures engines, controls, alternators, transfer switches, switchgear, and other components used in power generation systems (18% of 2010 sales).

The remainder of sales was derived from its Distribution segment, comprised of 19 company-owned and 22 joint-venture distributors that service and supply its products to end-users in North America and numerous global markets, including Australia, Europe, the Middle East, India, China, Africa, Brazil, and Japan.

Aided by strong demand from international markets and a rebound in the North American truck market, first-quarter net sales surged 55.8% year-over-year, to $3.86 billion. This was led by the Engine segment, where sales climbed 68%, to $2.39 billion, as total shipments increased 65.4% to 134,300 units.

Power Generation segment sales rose 53.8%, to $795 million, while Components and Distribution segment sales grew 46.7% and 34.9% to $924 million and $642 million, respectively.

The sales growth and productivity improvements helped the operating margin improve 279 basis points, to 13.52%. Net income jumped 130% to $343 million, or $1.75 per share.

We expect operations to remain strong over the near term, supported by continual demand from emerging markets, such as China, India, and Brazil.

Cooper Tire & Rubber Company (CTB)
Cooper is a leading global provider of replacement tires.

Its North American Tire Operations segment, which produced 71.5% of first-quarter sales, makes a wide range of emergency tires for passenger cars, light and medium trucks, racing cars, and motorcycles. These tires are sold through independent tire dealers, wholesale distributors, regional and national tire chains, and large automotive-supply chains.

CTB has done a great job of managing the higher cost environment we've seen since the first quarter. The company also implemented price increases of 8% to 9% in March, which should help offset some of the cost pressure.

Furthermore, CTB recently acquired the remaining interest in its China-based Cooper Kenda Tire joint venture (now known as Kunshan Tire) for $116.5 million. It also expanded its ownership in Corporacion de Occidente, a Mexican tire-manufacturing joint venture, to 58%. Because these operations provide a lower-cost source of tires, these investments should also have a positive impact on profit margins.

Despite the company’s recent investments in its joint ventures, CTB’s finances remain strong, with $224.7 million in cash and notes receivables and just $444.3 million in total debt.

CTB’s current valuation is also hard to ignore. Shares trade at just 8.6 times the consensus earnings estimate for 2011.

Finally, we are encouraged by the decline in oil prices. This could result in a deceleration of the company’s raw-material cost index earlier than expected.

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