Jewels Among the Junk

Even if you gave the gamut of auto parts suppliers more than a cursory glance, you'd likely still believe that they were little more than scrap metal these days. With all of the bankruptcies, earnings restatements, and debt downgrades, it's getting so bad that even relatively healthy companies are falling into the vortex of doom and gloom.

What a great time to go shopping for investments!

Diamonds in the rust
If there were ever a sector that seemed ripe for reaping Warren Buffett's advice -- "be greedy when others are fearful" -- the auto-parts-supplier business might be it. Let's look at some numbers to see how bad things are, and to understand just how good they could be.

It's quickly apparent that even without the almost-daily news reports trumpeting the industry's angst, this economic sector is deeply disturbed. The travails of both Ford and General Motors weigh heavily here. But just because many of these companies are rust heaps, don't assume all of them are. Here are three with promise.

Three to get ready
Magna International, Canada's largest auto parts supplier, expects 2005 sales to come in as much as 11% higher over 2004. However, it has also revised expectations down for the next two years, with average per-vehicle content prices declining as well. With nearly $1 billion in cash and a fairly solid balance sheet, it could still steal market share from its competition. Operating margins are consistent with its recent past, and it expects to boost profit margins, too. Though it's only off a little from its yearly highs, it still has room to go higher.

Similarly, exhaust system manufacturer ArvinMeritor also has a fairly healthy balance sheet that should serve it well in the coming shakeout. As one of the primary suppliers to the light-vehicle and heavy-truck markers, it's expecting a soft 2006, with its heavy-trucks segment expected to decline about 6% from the year before. Additionally, much of the bad news surrounding its setback on providing health care has been priced into the stock, so there's not much more downside risk here. Competitor Tenneco Automotive might be just as attractive, even though it's selling at its 52-week highs.

American Axle just announced that its "check engine light" came on, too. As the primary driveline supplier to General Motors, from whom it generates about 80% of its revenues, it said it will report significantly lower earnings on Feb. 3 than it had previously forecast. American Axle now expects to report only about $1.10 per share, compared with previous estimates of $1.40. But it just announced $1.4 billion in new business backlog, with $200 million coming from outside North America. Using a basic free cash flow calculation (operating cash flow minus capital expenditures and dividends), the company will be in the black. Because it's beholden to GM, however, this is perhaps the riskiest of the bunch.

Bonus opportunities
Don't overlook Visteon, either. While it's highly dependent upon Ford, it's not exclusively so, and it has seen some decent growth from its non-Ford customers. As a particularly depressed stock, it affords investors an opportunity to watch for a turnaround. You might not catch the bottom by waiting, but you'll reduce a lot of the risk inherent in a company that's teetering on the edge of bankruptcy.

Lastly, Motley Fool Stock Advisor pick BorgWarner generates positive free cash flow, offers tidy returns on investment, and is more than twice as profitable as any of its competitors. That helps explain why the drivetrain manufacturer's stock has more than doubled since it was recommended to Stock Advisor subscribers two years ago, and why it has been the company least caught up in the downdraft. The company expects growth to continue in line with its historical trends, but there may not yet be enough of a discount here to recommend a purchase. I'd keep an eye on it, though.

Foolish final thoughts
Stock prices for all the suppliers are already down from their annual highs, and further bad news from industry marquee names could depress them further. Most industry analysts and participants believe that 2006 will be a rough year. Investors who jump in with both feet now may only see further wreckage arise. I recommend that investors pick their entry points carefully; even amid the wrecks in this junk heap, one or two keepers might be found.

Jumpstart your investing engine with these related Foolish articles:

• Auto Parts: One Scary Biz
• The Junk Heap of Auto Parts
• Delphi's Depressing Oracle

Fool contributor Rich Duprey owns shares of Ford but does not own any of the other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.