Results speak for themselves

Jan. 1, 2020
Some of you may be tired of what you perceive to be our bountiful optimism over the fundamentals of the aftermarket and even our positive inclination on so many of the publicly traded equities in the space.

Some of you may be tired of what you perceive to be our bountiful optimism over the fundamentals of the aftermarket and even our positive inclination on so many of the publicly traded equities in the space.

While it may appear that we are “perma-bulls,” we would disagree and rather posit that the results of this space and continued favorable secular trends simply warrant a more constructive outlook. The two questions we continue to receive from investors are: 1) can secular trends for this group still provide a tailwind into 2011; and 2) have they “missed the trade?”

In our opinion, there are three main factors underlying the current strength of the aftermarket — elevated unemployment levels, depressed new vehicle sales and increasing failure rates of critical parts as vehicles age. While these three drivers are clearly interdependent, we think the combination of these factors should continue to support above-average growth rates for this industry well into 2011 and beyond.

During the “golden 90s,” the U.S. economy created an average of 175,000 jobs each month. While not economists, we are fairly comfortable in saying that job creation of this magnitude in the current economic morass is highly unlikely – and actual results over recent months have been even more gloomy.

The civilian non-institutional population of the U.S. has tended to increase by about 200,000 each month. And while the labor force participation rate can be a bit volatile — particularly when the prevailing perception is that work is hard to come by — by simply applying a long-term average of about two-thirds of the population one can quickly see why concerns are mounting about the likelihood of material declines in the unemployment rate even under the scenario of moderate economic recovery.

Given the strong inverse correlation between unemployment and new vehicle sales, the fact that lower new vehicle sales will spell an increasing average age of the fleet, which in turn will yield higher aggregate replacement rates for critical parts… well, I think you see the point.

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From an investment standpoint, the aftermarket has provided investors with strong returns in the face of a tough macro environment, with our group solidly outperforming the S&P 500 Index over the past year, month, and on a year-to-date basis. Over these time periods, the S&P 500 has returned +6.6 percent, -1.5 percent and -3.2 percent, respectively.

The median returns for our aftermarket coverage universe have been +25.4 percent, +0.9 percent and +8.5 percent, respectively, yielding outperformance of +18.8 percent, +2.3 percent and +11.7 percent relative to the key benchmark for U.S. equity performance.

In addition, approximately 85 percent of the aftermarket companies in our equity coverage universe have a higher estimated four-year earnings compound annual growth rate (CAGR) than the S&P 500’s 2.3 percent. Of these companies with a higher estimated four-year earnings CAGR, the median CAGR of 19.5 percent yields a material 17.2 percent outperformance relative to the S&P 500.

Looking to just 2011, a year which should continue to benefit from relatively benign earnings comparisons for the broader market, the consensus forecast calls for a 16.7 percent year-over-year increase in earnings per share (EPS) relative to 2010. And we would note that this forecast is predicated on some degree for a continued macro economic recovery. Yet, for the aftermarket in 2011, we expect 63 percent of our companies under coverage to grow earnings more quickly than the S&P 500 with a total median increase of 19 percent.

What about valuation? On estimated 2011 earnings, the S&P 500 is currently trading at a 24 percent discount to its five-year historical median forward price-earnings ratio (P/E). Interestingly, all 16 of our covered companies are also trading at a discount to their historical five-year median forward P/Es, with the median discount right in line with the S&P 500’s 24 percent.

The kicker though is that as noted above, the vast majority of our covered companies are likely to post EPS growth ahead of the broader market both on a four-year CAGR basis (85 percent) and again in 2011 (63 percent). With greater visibility and resilience in a sluggish macro environment, coupled with expectations for stronger earnings growth and in line relative valuation, we continue to believe that the aftermarket offers investors a unique opportunity to put money to work. Particularly as we see favorable secular industry drivers for some time to come.

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