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Members of the Society of Motor Manufacturers and Traders (SMMT) attending their annual jamboree at the London Hilton on 25 November could be forgiven for looking a bit wan. Car sales have plunged in the past two months. SMMT’s data for October shows UK car sales plummeted 23.5% year-on-year to just 128,352 units – the worst decline seen since a 31% plunge in July 1991 – when the UK was last in a deep recession. Luxury models such as Aston Martin are particularly hard hit. American car giant Ford may have its problems but at least it cleverly sold the British marque just before the worst of the crash. The Detroit-based firm plans to use £70 million of the cash it raised to modernise its engine plant at Bridgend in Wales.

Car components expert Tomkins (TOMK) deepened the gloom last week when its trading statement (5 November) admitted its end markets had worsened considerably since September. Tomkins shares fell 6% intra-day to 116p, barely above their year lows. The Automobiles & Parts sector’s performance ranks 39 out of the 40 sub-groups comprising the FTSE All-Share index. Nor is it easy to see what could spark a recovery, barring a sudden – and unlikely – rally in consumer confidence. Brave investors might chance their arms on GKN (GKN) riding out the storm due to the strength of its aerospace unit. There is also good news on the environmental front as the European Union is considering giving car companies ?40 billion to invest in green technology. Car makers say slumping sales and tight credit markets make it hard for them to fund the switch to less-polluting cars themselves. Even so, more speculative counters such as Proton Power Systems (PPS:AIM) and KleenAir Systems International (KSI:AIM) remain best avoided in this risk-averse equity environment, for all the potential of their technology.

Sharp decline

‘We are facing what will turn out to be the worst recession in the post-war period. We will need less components and less engines and the trick will be to try to make sure we minimise the effects of that reduction,’ says car industry expert Professor Garel Rhys of Cardiff Business School. ‘Manufacturers are all aware of this and they are trying to find the best way to weather the storm.’

Outside the UK the European car industry will suffer a further drop in sales in the fourth quarter of this year, according to a speech given last month by the head of European Automobile Manufacturers Association (ACEA).

‘In the third quarter, there was a drop of about 10%... In the fourth quarter it will be even more,’ said Christian Streiff, who is also chief executive of France’s PSA Peugeot Citroen. ‘It is quite clear now that the banks are not following us and neither are the clients... there is a lack of a market,’ he continued.

US auto sales slumped to 25-year lows in October, led by a 45% drop at General Motors (GM). There is no sign the market has hit bottom either. Doubts persist whether all the big three US automakers – Ford, Chrysler and GM – can survive, hampered by crushing pension and healthcare burdens

as well as the poor

operating environment.

The Japanese have suffered too. American sales for Toyota dived 29%, Honda 25% and Nissan 33%, versus a 30% slide at Ford. A swift US recovery is also unlikely as consumers face tighter credit and deepening uncertainty about the strength of

the economy.

Production cuts

Apart from Volkswagen, which has been the subject of the extraordinary short squeeze caused by Porsche’s planned takeover of the Lower Saxony-based firm, all major car makers have seen their share prices collapse in expectation of sharply falling profits.

In response major car companies such as Peugeot Citroen and Renault are slashing production, although Volkswagen insists it will sell more units this year than last. Nissan is also substantially cutting output at factories in the UK and Spain. Daimler, the maker of Mercedes-branded cars, issued a profits warning in October and Italy’s Fiat said EU sales could fall 20% in 2009. Jaguar Land Rover, bought by Tata Motors from Ford, announced 200 job cuts last month

These cuts further pressure component makers such as Tomkins, whose shares have halved in the past year and can only further serve to depress sentiment toward a British industry which is in many ways a light of former days.

At least major global automotive companies have been attracted to the UK by engineering excellence, workforce skills and the supportive business environment. More than 40 companies make vehicles in the UK with high-profile global investors including Ford, BMW, Toyota, Nissan and Honda. UK design and engineering companies are in demand for states developing world-class automotive industries. One of these key emerging markets is China – where UK firms such as Lotus Engineering, Ricardo (RCDO), MIRA, Prodrive, Concept Group International and Arup have an increasing presence, having recently opened local offices.

In pieces

UK components companies also have market-leading positions in several areas that have combined to boost demand for vehicle parts and accessories, although they rely heavily on the investment plans of the major UK-based manufacturers.

In 2006, the UK market for automotive components was estimated £14 billion, up from £13.2 billion in 2005. The UK-based industry employs a diverse workforce of 124,000 . It is estimated the automotive components sector supports a further 70,000.

Over 1,000 automotive component suppliers manufacture in the UK, including global players such as Delphi, Bosch, Visteon, Federal-Mogul and TRW. UK-owned component manufacturers such as GKN, Unipart

and Pilkington are

world-renowned.

But countries such as Turkey, Romania, India and China pose ever stiffer competition. Multinationals such as Ford, Rover and Peugeot have taken their business elsewhere over the past two years with devastating consequences, hitting workers on vehicle production lines, component companies and workers in secondary organisations who rely on these factories (see table on production moved out of the UK).

Disparate bunch

The remaining quoted UK car and auto component firms range from automatic transmission inventor Antonov (ATV:AIM) to struggling car parts specialist Wagon (WAGN). Engineering giant GKN dominates the scene, its strength in aerospace just been supplemented by its purchase of the Airbus wing-making plant at Filton in Bristol. But even GKN’s shares have nosedived from over 400p in summer 2007 to just above recent lows at 119p on expectation of a profits slump in 2009. Although aerospace could be the firm’s biggest revenue contributor by 2011, more than half its sales still come from automotive industry today.

The market value of the other quoted UK based companies in the auto sector amounts to barely a fifth of GKN’s £840 million capitalisation.

Torotrak (TRK) is one of the largest but is worth just £20 million as it has never made a profit. Its shares have sunk from 125p in 2004 to 14p as the crucial licence sale breakthrough seems always just around the corner.

US billionaire Wilbur Ross controls Wagon and is expected to merge it with his other European car parts companies. It is doubtful whether investors will be treated generously as the shares have fallen from 199p to 1p in the past five years. Wagon’s shares were suspended in October pending discussions regarding the firm’s financial position involving the banks and Ross, who lost over £5 million when he underwrote a rights issue priced at 4p in August, taking an 86.4% stake in the process.

Transense Technologies’ (TRT:AIM) ‘unique’ tyre pressure monitoring technology failed to find many buyers. The shares were 142p at their peak last year but stand at barely 4p today.

Newcastle-based fuel cell outfit Proton Power Systems (PPS:AIM) reports five-figure sales and seven-figure losses. Clean Diesel Technologies Inc (CDTI:AIM), the clean tech emissions reduction company, made a recent licence sale to Hilite for its technology. Revenue trebled to $5 million last year and should double to over $10 million this year. It is a leading supplier of emission control technologies for the London Low Emission Zone (LEZ), though the company is expected to remain loss-making this year.

Another vehicle emission reduction device developer KleenAir Systems International is worth just £1.9 million with virtually no sales, big losses and debts exceed shareholders funds.

Slow vehicles

On the commercial vehicles side, the ambitious plans of London taxi cab maker Manganese Bronze Holdings (MNGS) to sell black cabs in China may or may not succeed in partnership with Shanghai motor group Geely. UK sales are plunging due to the recession and it is uncertain whether overseas taxi drivers will warm to this British export and rescue a tottering share price.

The shares of Titan Europe (TSW) had fallen from over £2 to 17p a few weeks ago before recovering a tad. Talks with former parent Titan International failed to agree a bid. Titan makes steel wheels for tractors and undercarriages for trucks. The size of current-year profits depends on Titan ability to pass on the big steel price rises to its customers, which it said was ‘highly uncertain’.

Optare (OPE) designs and assembles single and double-deck buses for operators such as Stagecoach (SGC) and National Express (NEX). Optare’s shares have plunged around two-thirds since floating earlier this year with first-half losses totalling £2.6 million.

Concrete flooring specialist Somero Enterprises (SOM:AIM) is a surprise constituent of the commercial vehicles sub-sector. It is also close to joining the 90% club with pre-tax profits falling sharply in the first half of 2008.

Welsh automation systems expert C.H. Bailey (BLEY) probably owes its strong share price performance more to family and friends controlling most of the equity. Sales have been flat at around £11 million and losses last year were £1.5 million. At 67p the company is worth £5.5 million. Jarlway Holdings (JWY) sells concrete pumps to construction industry customers in China, though apparently with mixed results as it lost £1.1 million on £6.8 million sales in 2007. The company’s market cap is just £90,000.

Motorsport showcase for Britain

All eyes are on the British motor sport industry after Lewis Hamilton’s sensational Formula 1 (F1) World Championship victory last week. The F1 industry contributes over £5 billion a year to the UK economy and half of this is accounted for by exports. The industry employs around 40,000 including 25,000 skilled engineers.

Motorsport Valley, based largely in southern and central England, is the hub of British output.

It boasts a unique cluster of high-performance engineering companies, acting as a global centre for the production of performance cars, chassis, engines, brakes, suspension and transmission systems, telemetry and a wide range of other world-class products, services and facilities.

Flexibility in the production of leading-edge quality products is one of Motorsport Valley’s many selling points. Its extremely diverse supply chain incorporates dynamic small and medium-sized enterprises and major industry leaders.

The cluster is renowned for its ability to react quickly to specific industry requirements – perfect for clients that need complex precision components incorporating the latest technology to be designed, prototyped and manufactured on a fast-track basis.

Motorsport Valley accounts for a major proportion of the world motor sport industry market and is home to some of motor racing’s biggest names. These include high-profile F1 and Formula 3 teams, globally active component manufacturers, an array of design and engineering experts, and several racing team operators.

London is also a key part of the UK motor sport cluster. The capital is home to the rights holders and organisers of F1 and the World Rally Championships, with both being run by the FIA from an office at Silverstone, together with the many specialised legal and insurance companies vital to global motor sport.

Key auto facts

• The UK automotive sector is worth over $9 billion and currently

accounts for over 11% of the UK’s total exports

• The UK automotive industry employs around 820,000 people

with 180,000 directly in manufacturing and 6,000 as

component suppliers.

• Britain’s Johnson Matthey (JMAT) is the world’s largest

manufacturer of catalytic converters – helping vehicles reduce

potentially harmful emissions.

• More than 65% of UK commercial vehicle production in 2006

was exported.

• Seven out of 11 Formula One teams are based in the UK –

Renault, Williams, Honda, McLaren, Red Bull Racing, Super Aguri

and Force India (Red Bull and Force India are both based

at Silverstone).

• The Nissan plant in Sunderland and Toyota plant in Derbyshire

are two of the most productive car plants in Europe.

• The new BMW MINI is exported to over 80 countries

Source: UK Trade & Investment

GKN (GKN) 123p

Reaching for the long-term skies

GKN’s profit warning at the end of October was not unexpected given the automotive sector collapse, and the shares had already plunged ahead of the trading alert. The stock now looks good value for long-term investors on a prospective price/earnings ratio of barely five for 2008 and a yield of nearly 7%, even if the payout is cut from last year’s 13.5p to 9p.

At 9p the dividend payment will still be covered almost three times, although if 2009 earnings undershoot the consensus forecast of £185 million it could come under further threat.

Famous for its constant velocity joints GKN is re-inventing itself as an aerospace parts manufacturer. It is buying the Filton factories in Bristol, once owned by BAE Systems (BA.), from Airbus Industries and is collaborating with Rolls-Royce (RR.) on the use of composite materials to make fan blades for jet engines. The growing aerospace exposure should mean GKN can weather the economic storm better than most, not least as its borrowings are comfortable at 43% of shareholders’ funds, and cashflow is strong. Interest cover was 2.1 times last year and should remain at close to two times this year and next.

The interim management statement revealed a £4 million decline in third-quarter profits and management cautioned income in the final quarter is expected to slide by around £11 million due to a slump in car and van sales. This implies profits will be around 20% lower than last year at around £183 million.

GKN is taking action by cutting capital spending and overheads. There will be plant shutdowns and redundancies. On the bright side raw material costs have fallen sharply with scrap steel costing $230 a ton against $870 a ton in July.

Titan Europe (TSW:AIM) 22p

High risk, potentially high reward

Titan is a highly speculative punt for aggressive investors, where high risk could be compensated for by high returns. Falling steel prices should be a massive boost for the maker of wheels for tractors and undercarriages for trucks and help Titan stave off a major earnings decline in 2009.

Forecast sales over of £300 million for 2008 dwarf the firm’s £18.3 million market cap, even once its £131 million net debt is accounted for. Interest cover on that debt was more than three times last year although a major drop in profits from the £22 million expected for 2008 would see that drop below two times, traditionally a warning sign for operationally geared manufacturers.

Last year’s dividend of 6.5p implies a yield of over 25% and is clearly for the chop, although the share price plunge seen in 2008 reflects this. It is not impossible the dividend is passed altogether in 2009.

Titan has strong market positions and its Italian acquisition a few years back has bedded in well. Better still, former parent Titan International might well return with a bid building on its 17% stake and it is interesting to note executive directors increased their holdings slightly a few weeks ago. Profits could rebound strongly in 2010 making the current price look a bargain.

Proton Power Systems (PPS:AIM) 8.8p

Mind the gap

Sometimes it pays to be cynical. When a company wins a prize for its technology it is often time to sell as the gap between invention and profitable production is immense and frequently never bridged.

Hundreds of companies are developing fuel cells with dozens of different technologies. Yet it is not even certain there will be demand for fuel cells even if they ever become economically viable. Admittedly the latest interim figures from Hamburg-based Proton showed a decent increase in sales, from £295,000 to £455,000, but losses swelled from £951,000 to £1.3 million.

If the company can start volume production of fuel cells the cost will fall to more economic levels. Certainly cash does not seem a problem at present, with Proton tapping its big backers for £6 million in recent months, matching its current market valuation, but this is the sort of jam tomorrow stock that is likely to be dealt with harshly in the current market environment should there be further disappointments.

CONCLUSIONS: AUTOMOBILES & PARTS

BULL POINTS BEAR POINTS

• Stocks already de-rated • Plunging demand

• Green technology potential • Lofty raw material prices

• Industry consolidation • Production cuts

Risk to earnings forecasts : 1 (5=upside risk, 1=downside risk)

Earnings predictability: 2 (5=very high,1=very low)

Valuation: 3 (5=very cheap, 1=very expensive)

Balance sheet strength: 3 (5=cash rich, 1=heavily indebted)

Cashflow: 2 (5=very strong, 1=very weak)

Over-owned: 2 (5=all brokers negative, 1=all positive)

Total 13/30

Stocks to buy: GKN

Stocks to avoid: KleenAir Systems Intl, Proton Power Sys., Jarlway Hds.

Total Broker Buy ratings on stocks: 6

Total Broker Hold ratings on stocks: 3

Total Broker Sell rating on stocks: 2

SHARES RATING

SELL