The auto industry set to shift gears

Looking beyond supply-chain disruptions within the automotive industry, parts suppliers appear well-positioned as production headwinds abate and order backlog remains elevated, points out Fidelity’s Hiroki Sugihara.

“These headwinds, which started with semiconductor shortages in late 2020, incrementally worsened in early 2022 amid Russia’s invasion of Ukraine and additional COVID-related lockdowns in China,” says Sugihara, portfolio manager of Fidelity^® Select Automotive Portfolio (FSAVX).

In fact, he highlights that some raw materials crucial to auto manufacturing became less available, given that they were predominantly procured from Russia. Elsewhere, renewed lockdowns in Shanghai halted production lines of many automakers because several key suppliers are based in the vicinity of China’s biggest city.

In managing the fund, Sugihara favors high-quality businesses exhibiting above-average growth due to a strong electric vehicle portfolio; a robust geographic sales mix; suppliers with growing content per vehicle that are outpacing their competitors; and companies that are repurchasing shares, thereby accelerating earnings-per-share growth.

Despite the challenging backdrop, he has finally started to see some improvement in supply chains. Case in point, severe supply disruptions from major citywide lockdowns in China appear to be mostly behind us.

Additionally, Sugihara notes that some chipmakers increased automotive semiconductor production, which he thinks could finally help vehicle manufacturers catch up.

Furthermore, demand for autos remains high in many regions of the world, including North America. “Therefore, when manufacturers’ production normalizes, it should be met with heightened demand, leading to a sequential increase in auto production moving forward, barring any new supply-chain disruption,” he adds.

Shifting gears, this scenario also favors auto-parts suppliers, which historically benefit during periods of rising automotive production because their profit margins are highly sensitive to production volume, Sugihara highlights.

“As validation, I’ve been hearing positive updates from these businesses on gradually being able to pass along much of their cost increases to customers via higher pricing, which had previously weighed on profitability,” contends Sugihara.

For these reasons, he has recently boosted the fund’s exposure to auto parts and equipment stocks—including Japan’s Denso (DNZOY) and Irish American firm Aptiv (APTV), sizable holdings as of December 31—amid expectations for margin expansion and valuation re-rating within this space.

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