The Simplified Investor

The problems plaguing the Big Three American auto makers in 2008 have been well-documented.  The push for flashy SUVs that guzzle gas but impress at the suburban strip mall caused Ford, GM, and Daimler to shift production towards these bigger cars, but these divisions have become huge drains on profits in recent quarters.  Consumers have responded to the explosion of oil and gas prices and stopped buying trucks and sport utility vehicles, looking instead toward more fuel-efficient and hybrid vehicles.

Europe drank the renewable energy Kool-Aid long before it reached America, and the big car companies have already focused their European and international production on smaller cars that consume less gasoline.  As the global economy sags, these economical cars have continued to sell, and results abroad have been the lone bright spot for Ford, GM, and lower-profile players in the auto manufacturing industry.

One such smaller player is TRW Automotive (NYSE:TRW), which makes auto parts and auto safety components.  TRW’s earnings have grown steadily in the second half of 2007 and first half of 2008 (to $127M in second quarter 2008) on the strength of its international sales - which were 58% of the company’s 2007 revenues.  Its stock price, however, has not followed suit - instead, it has sunk with the rest of its industry as investors continue to fear that the trouble has just begun for companies that make cars and associated parts.

But a closer look at this stock indicates that the market may be missing something when it lumps TRW in with its Michigan cohorts.  First, there are the international revenue numbers - just 30% of revenues in 2007 came from the depressed North American market.  Another important consideration is the company’s focus on auto safety equipment like airbags and seatbelts.  Safety equipment was 32% of TRW’s revenue in ‘07, but 56% of the company’s pre-tax earnings as the products sell at high margins.

TRW Automotive's Revenue by Geography and Business Segment, 2007 (Source:Wikinvest.com)

2007 Market Share, Makers of Auto Safety Components

Thus, at 56% of earnings, demand for TRW’s safety products is a key driver of their growth.  This is contingent on demand for cars - and on legislative changes to auto safety regulations.  In the U.S., for example, in 2007 the Traffic Safety Administration mandated that all cars must have side airbags by 2012, and TRW’s revenues from the safety segment grew 10% that year.  It stands to reason that governments will continue to emphasize safety, along with fuel efficiency, in coming years - and since it controls a 25% market share, TRW should benefit.

It’s worth noting that while competitor Autoliv, Inc. controls more of this market, TRW has more than double the revenues.  That’s because of the company’s diversified business model, in which half of revenues (but just a third of net income) come from making chassis parts like brakes and steering systems.  In this business, TRW relies heavily on three key customers, Volkswagen, Ford, and General Motors.  So a bet on TRW is also a bet on the continued business of these three major firms.  Nonetheless, with its international focus, heavy earnings from safety parts, and recent growth, TRW could be a good bet for an investor looking for the auto market to rebound.

Tags: Auto Makers, Auto Manufacturing, Auto Parts, Automobiles, Big Three Auto, Car Makers, Cars, Daimler, Ford, General Motors, GM, Investing, Manufacturing, Stocks, TRW, TRW Automotive, Volkswagen

This entry was posted on Thursday, September 4th, 2008 at 12:26 pm and is filed under Auto Makers, Stocks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.