Autos Auto Parts Auto Supplier Update

Equity Research Industry Comments Autos & Auto Parts Auto Supplier Update September 12, 2007 Michael Ward 203-662-1115 mpw@wardct.com Sales and Research 1-800-447-4318 Trading 1-800-569-2407 www.soleilgroup.com Sector Coverage Ticker Price GPC AXL BWA JCI LEA TRW VC F GM $48.58 $21.88 $83.34 $108.94 $27.55 $29.30 $4.90 $7.58 $30.54 Action Rating Buy Hold Hold Hold Hold Hold Hold Sell Sell On average the eight stocks in the Ward Transportation Research Supplier Comp Group beat the S&P 500 by 15% on a total return basis in the first quarter of 2007, following positive comments at the Detroit Auto Show. Over the last two months, the group has given back more than 10% to the market, owing in part to growing concerns about volume levels in North America and ongoing inflation pressures. Weakening industry demand, market share erosion at the Detroit Three, and excess dealer inventory levels should continue to limit North American production totals into 2008. Modest production levels along with inflationary cost pressures and limited pricing should lead to another tough year of financial performance for the supplier group. We remain cautious with each of the six suppliers under coverage, but would be opportunistic with BWA, JCI or TRW if near-term events push the stocks lower. • Organic revenue for the supplier group has been slowing over the last few years and we expect weakening industry conditions in North America will limit growth into 2008. • Margins for the group have recovered from the lows of 2005, but remain a few points below the levels earlier this decade. • Supplier multiples have come down since June, but remain above recent comparisons. Suppliers with less exposure to the Detroit Three and to the North American market, in our opinion, have a better chance to outperform the group. Important disclosure information is contained on pages 18 - 19 of this report. The recipient of this report is directed to read these disclosures. Auto Supplier Update Industry Note Industry Update – Tough Time in Motown Following a fairly steady increase throughout the 1990s, U.S. light vehicle sales have been drifting lower since September 2000 when industry sales peaked at 17.6 million units. Recent data and indicators suggest the probability remains high that the weakness will extend into 2008. The Figure below looks at the U.S. sales cycle on a 12-month moving total basis, comparing it against trend and providing the peak-to-trough declines of the past. As can be seen in the chart, the drop-off from the 2000 peak has been modest by historical standards, but more recently, the pace of decline has accelerated. The combination of concerns in the credit market, weakness in the housing sector, reduced effectiveness of marketing incentives, and the level of demand over the last eight years, in our opinion, will lead to weaker-than-expected totals over the next 6-12 months. Our current forecast is for a 2.4% decline in 2007 to 16.1 million units, and we expect another modest drop in 2008 to 16.0 million light vehicles. U.S. Retail Car & Light Truck Sales (mil) 19.0 -35% 17.0 -7% 15.0 13.0 -23% 11.0 9.0 1976 1980 1984 1988 1992 1996 2000 2004 Source: Ward's Automotive & WTR The Figure below looks at U.S. light vehicle sales for the month of August versus the comparable 2006 period, the total for the first eight months, annual data for 2005 and 2006 and our estimates for 2007 and 2008. The financial weakness in the North American industry has caused many to believe Detroit is once again in the depths of a cyclical downturn. However, the industry remains at fairly high levels, but market share erosion at the traditional Big Three has resulted in recessionary volume levels. The combination of shifting demographics and an overdependence on light trucks at the wrong time have contributed to the share loss, leaving the Big Three to rely on marketing incentives in order to move the metal. In 2006, each of the Detroit Three lost share, dropping a combined 3.1 points, with Toyota (TM: NR) and Honda (HMC: NR) the primary winners. We expect more of the same in 2007 and 2008, each of the Big Three has plans to reduce shipments to rental fleet customers, and the discontinuation of key models at Ford (F: Sell) should continue to keep pressure on share performance. Industry sales in the first half were down 1.6% from last year, but General Motors (GM: Sell) and Ford both posted sharper declines and lost share. Toyota continues to gain momentum; sales increased 9%, pushing its share to within 0.1 of a point from taking second place in the market. -2- Auto Supplier Update Industry Note U.S. Light Vehicle Sales (000) Total Car & Light Truck GM Ford Chrysler Honda Nissan Toyota VW Koreans Other Total Market Share GM Ford Chrysler Honda Nissan Toyota VW Koreans Other Aug 06 364 249 179 151 90 240 31 70 109 1,483 Aug 07 386 212 168 158 96 233 29 72 118 1,473 YTD - 06 2,807 2,003 1,459 1,044 688 1,706 217 524 872 11,320 YTD - 07 2,600 1,745 1,419 1,066 719 1,789 217 533 906 10,994 2005 4,457 3,107 2,304 1,462 1,077 2,260 307 731 1,242 16,948 2006 4,068 2,850 2,143 1,509 1,019 2,543 325 750 1,298 16,504 2007E 3,750 2,600 2,125 1,520 1,035 2,645 315 770 1,340 16,100 2008E 3,715 2,570 2,085 1,530 1,010 2,665 310 775 1,340 16,000 24.5% 16.8% 12.1% 10.2% 6.1% 16.2% 2.1% 4.7% 7.4% 26.2% 14.4% 11.4% 10.8% 6.5% 15.9% 2.0% 4.9% 8.0% 24.8% 17.7% 12.9% 9.2% 6.1% 15.1% 1.9% 4.6% 7.7% 23.7% 15.9% 12.9% 9.7% 6.5% 16.3% 2.0% 4.8% 8.2% 26.3% 18.3% 13.6% 8.6% 6.4% 13.3% 1.8% 4.3% 7.3% 24.6% 17.3% 13.0% 9.1% 6.2% 15.4% 2.0% 4.5% 7.9% 23.3% 16.1% 13.2% 9.4% 6.4% 16.4% 2.0% 4.8% 8.3% 23.2% 16.1% 13.0% 9.6% 6.3% 16.7% 1.9% 4.8% 8.4% Source: Ward's Automotive & WTR (GM: Sell; F: Sell; DCX: NR; HMC: NR; NSANY: NR; TM: NR) The most significant change in the U.S. light vehicle market over the last few years has been the increased preference for Small Vehicles away from People Carriers. The combination of shifting demographics, unstable fuel prices and the availability of products in the Small category that satisfy many of the needs of traditional People Carriers, in our opinion, have led to the move. Small Vehicles include everything from small cars to small sport utility vehicles and crossover vehicles. The segment peaked at over 38% of the U.S. market in 1987 and declined steadily until 1999 when it reached 23.7% of the industry. We believe the key demographic for the Small Vehicle buyer is the 15-29 year old age bracket, or those looking for basic transportation at an affordable price. The U.S. population of people aged 15-29 years old hit a low of 55 million in 1996, but has grown steadily since children of the baby boomers aged, and the total is expected to reach 63 million by 2010. In addition, between the late-80s and late-90s, gas prices remained relatively stable in the $0.90-1.25 per gallon range, but since 2000, prices have been increasing, moving past the $3.00 per gallon level. The level and volatility of fuel prices has been an incentive for some to look for a smaller, more fuel efficient vehicle that's able to satisfy most of the basic needs. Toyota introduced the Rav4 in 1996, a car-based sport utility vehicle (CUV) in 1996, followed by Honda and others in 1997. CUV sales totaled 540,000 units in 2000 and should reach 2.5 million units this year. The Figure below looks at the penetration of the four key marketing segments since 1985. The Luxury and Pickup & Large Van segment have been fairly stable, but as can be seen in the chart, Small Vehicle has been taking a larger chunk of the market at the expense of the People Carriers. -3- Auto Supplier Update Industry Note U.S. Light Vehicle Sales - Segment Share of Total 48% 36% 24% 12% Small People Carrier Luxury Pickup & Van 0% 1985 1990 1995 2000 2005 Source: Ward's Automotive & WTR The trend to smaller vehicles is negative for the Detroit Three manufacturers as well as their suppliers. The Detroit Three account for close to 80% of traditional sport utility vehicles (SUVs), which are mostly classified in the People Carrier Segment, but only account for about 42% of CUVs, which are generally included in the Small Vehicle segment. As the market preference has shifted away from SUVs to CUVs, the Detroit Three have lost (SUV sales peaked at 3.0 million units in 2000 and are expected to fall to 2.0 million units in 2007.). The trend hurts suppliers in two ways; the smaller CUVs are generally cheaper and have less content, and about 90% of SUVs are produced in North America compared to only 60% of crossovers. The next Figure looks at the percentage of vehicles in each of the four marketing segments that are sourced in North America. The shift in consumer preference toward smaller vehicles compounds the effects of industry volume declines, moving content away from North America and favoring foreign-based suppliers. U.S. Segment Sales - Percent Produced in North America 100% 75% 50% 25% 0% Small PC Source: Ward's Automotive & WTR estimates Luxury Pickup On a combined basis, the Detroit Three have lost more than 14 points in U.S. light vehicle share since 2000, and most of it has gone to Honda, Nissan (NSANY: NR) and Toyota. The market share declines at the Big Three have led some to conclude that the industry is once again in the depths of a recession, creating optimism that demand resurgence will help offset excessive costs. Unfortunately, overall industry totals remain -4- Auto Supplier Update Industry Note close to the all-time highs, but the lost market share has largely accounted for the financial pressures. The next Figure looks at total industry sales on a 12-month moving total basis compared against combined sales for the Detroit Three. Total sales are below any recent comparison and we believe the declines will accelerate into 2008. U.S. Light Vehicle Sales (12-month moving total - mil) 18 Total Industry Big 3 14 16 12 14 10 12 1985 1988 1991 1994 Source: Ward's Automotive & WTR 1997 2000 2003 2006 8 The bottom line is that North American production has been declining and should head lower this year and next. The next Figure looks at North American production for GM, Ford and the overall market, comparing our forecast for the third and fourth quarters of 2007 against year-earlier data, and provides our annual assumptions for 2007 and 2008. Industry production should end at about 15.4 million units in 2007, down 3% from last year, but 13% below the recent peak in 2000. More importantly, production at the Detroit Three has dropped 27% from the 2000 peak and the industry has been supported by the expansion of transplant production. North American Production Forecast (000) 3Q '06 3Q '07E General Motors N.A. Car N.A. Truck Total N.A. Production Ford N.A. Car N.A. Truck Total N.A. Production Industry % chg 4Q 06 4Q 07E % chg CY '05 CY '06 CY '07E CY '08E 417 631 1,048 375 670 1,045 -10.0% 6.2% -0.3% 447 658 1,105 335 664 999 -25.0% 0.9% -9.6% 1,835 3,009 4,844 1,821 2,819 4,640 1,510 2,725 4,235 1,510 2,620 4,130 254 387 641 185 440 625 -27.1% 13.7% -2.4% 243 362 605 203 438 641 -16.4% 21.1% 6.0% 1,015 2,271 3,286 1,141 1,858 3,000 830 1,970 2,800 875 1,850 2,725 N.A. Car N.A. Truck Total N.A. Production 1,552 2,005 3,557 1,535 2,110 3,645 -1.1% 5.2% 2.5% 1,654 2,104 3,758 1,546 2,175 3,721 -6.5% 3.4% -1.0% 6,524 9,805 16,329 6,854 9,023 15,877 6,425 9,010 15,435 6,490 8,885 15,375 Source: Company reports, Ward's Automotive & WTR estimates The weakness in industry sales, the shift in consumer buying patterns, and the share loss in Detroit exacerbates the problems in the supplier community. The next Figure highlights the percentage of revenue each of the eight suppliers generated with the Detroit Three in 2006 (the 2006 data includes Daimler and Chrysler on a combined basis although we don't believe the Daimler portion is significant). As can be seen in the table, each of the suppliers has significant exposure to Big Three manufacturers, but American -5- Auto Supplier Update Industry Note Axle (AXL: Hold), Lear Corporation (LEA: Hold) and Magna (MGA: NR) are hurt the most by the troubles in Detroit; Johnson Controls (JCI: Hold) and BorgWarner (BWA: Hold) have the least amount of exposure to the Detroit Three in North America. SupplierCustomer Mix 2006 AXL - Hold ALV - NR BWA - Hold JCI - Hold LEA - Hold MGA - NR TRW - Hold VC - Hold Source: Company reports & WTR GM 76% 12% 9% 11% 32% 25% 11% na Ford na 20% 13% 10% 23% 14% 15% 45% DCX 14% 6% 11% 11% 10% 24% 14% 2% Financial Update In the early part of the decade, the eight companies in the Ward Transportation Research Supplier Comp Group were able to grow organic revenue (net of currency effects and incremental revenue from acquisition) an average of 8-10% annually. In 2005, North American production totaled 16.3 million units, and the key global markets were close to all-time records, helping revenue for the group grow an average of 4%. Since then, industry conditions in North America turned down, especially for the Detroit Three, organic revenue for the group declined, and the weakness continued into the first half of 2007. The Figure below looks at average revenue growth for the eight companies in the Ward Transportation Research Supplier Comp Group over the last few years. The Comp Group includes: American Axle (AXL: Hold), Autoliv (ALV: NR), Borg Warner (BWA: Hold), Johnson Controls (JCI: Hold), Lear (LEA: Hold), Magna (MGA: NR), TRW Automotive (TRW: Hold), and Visteon (VC: Hold). The combination of lower industry build rates in North America, market share declines at the Detroit Three, and annual price adjustments for the vehicle manufacturers will likely keep pressure on overall supplier performance into 2008. Suppliers that have the best chance for growth at a faster pace than the overall market will be those with a minimal dependence on the Detroit Three and solid positions overseas. Of the companies under coverage in our comp group, BWA and TRW generate more revenue outside North America (60% and 67%) and the Detroit Three account for 33% and 40% of revenue respectively. JCI's controls business (about one-third of total revenue) is a meaningful diversion from the auto sector and the company enjoys a good supply position with the foreign-based manufacturers operating in North America, especially Toyota. -6- Auto Supplier Update Industry Note Supplier Comp Group - Revenue Analysis (YOY change) 11% 8% 5% 2% -1% 2002 2003 2004 Source: Company reports & WTR estimates 2005 2006 YTD 07 The next Figure looks at the combined EBITDA margin for the eight companies in our Supplier Comp Group, looking at performance between 2001 and 2006 as well as the first six months of 2007. The group recorded margins of 8.6% and 8.5% in 2001 and 2002, but performance has declined steadily along with the fall-off in North American production levels. Through the first six months of 2007, EBITDA margin for the group totaled 7.8%, flat with the first half of last year, but continued volume pressure likely result additional margin pressure in the second half. Supplier Comp Group - Average EBITDA Margin 9% 8% 7% 6% 5% 2001 2002 2003 2004 2005 2006 YTD 06 YTD 07 Source: Company reports & WTR estimates In addition to the adverse industry environment in North America, several other cost items have had an impact on margin performance for the supplier group. The next Figure looks at warranty costs for the six suppliers that provide quarterly detail (ALV, BWA, JCI, LEA, TRW, and VC). Although warranty only accounts for about 0.4% of revenue, costs have more than doubled for the group since 2002 and should increase once again this year. The vehicle manufacturers have looked to suppliers to share more of the burden for warranty. -7- Auto Supplier Update Industry Note Supplier Comp Group - Warranty Costs (mil) $325 $275 $225 $175 $125 $75 2002 2003 2004 2005 2006 YTD 06 YTD 07 Source: Company reports (includes: ALV, BWA, JCI, LEA, TRW, VC) Legacy costs have been mixed for the supplier group. Upon the completion of the ACH transactions with Ford, Visteon's legacy expenses dropped from $523 million in 2005 to $88 million in 2006, accounting for the overall improvement for the group. The next Figure looks at legacy costs as a percent of revenue for the eight companies in the Supplier Comp Group since 2004. Costs have declined since 2005 as a result of the changes at Visteon, but the total for the rest of the group has actually increased. Through the first half of 2007, legacy expenses as a percent of revenue were flat, but actual costs have come down in each of the first two quarters this year providing some benefit for the group. Supplier Comp Group - Legacy Costs / Revenue 1.2% 0.9% 0.6% 0.3% 0.0% 2004 2005 2006 Source: Company reports & WTR estimates YTD 06 YTD 07 Net debt for the eight stocks in the supplier group amounted to $10.9 billion at the end of June, down from $11.3 billion at year-end 2006 and $12.2 billion at the end of 2005. Group debt expanded from $9.1 billion at the end of 2003 owing largely to JCI's acquisition of York at the end of calendar year 2005. Since then, profitability has been flat or lower, capital spending has moderated, and there has been only limited activity on the acquisition front. The next Figure looks at the net debt balance (total debt less cash and equivalents) on a combined basis for the eight companies in our Supplier Comp Group. -8- Auto Supplier Update Industry Note Supplier Comp Group - Net Det (bil) $14 $11 $8 $5 YTD 06 Source: Company reports (includes: ALV, BWA, JCI, LEA, TRW, VC) 2001 2002 2003 2004 2005 2006 YTD 07 Debt levels and coverage ratios remain at manageable levels for most companies in the supplier group, despite the adverse industry conditions and the number of bankruptcies that hit the group between 2004 and 2006. The Figure below looks at average annual financial metrics for the eight companies in the Supplier Comp Group. As can be seen in the table, debt metrics have slipped a bit from the 2002-03 period, but the group remains in pretty good shape. -9- Auto Supplier Update Industry Note Ward Transportation Research Auto Supplier Comp Sheet - Year-end Summary Comp Group Equity Valuation Market Capitalization (mil) Market Cap/Revenue P/E ratio - trailing 4q EV/EBITDA Book Value Price to Book Dividend Yield Debt Ratios Net Debt/Invested Cap Net Debt/EBITDA Total Debt/EBITDA Pension Status * Net Debt + Pension/EBITDA EBITDA/Interest Financial Performance Revenue Growth (12-mos) EBITDA Margin EPS Growth - trailing ROIC Return on Avg Equity Cap Exp/Revenue Inventory/Revenue SG&A/Revenue 2002 2003 2004 2005 2006 YTD 07 $ 2,865 $ 4,402 $ 4,631 $ 4,560 $ 5,173 $ 6,518 32.3% 45.0% 42.2% 37.1% 39.7% 48.3% 9.1 13.1 12.4 13.9 13.8 17.7 4.2 6.1 5.3 6.4 6.1 7.4 $ 24.58 $ 24.26 $ 25.67 $ 23.71 $ 26.19 $ 27.66 1.5 0.5 0.5 0.4 0.4 0.2 1.6% 1.2% 1.5% 1.8% 1.3% 1.0% 40.4% 40.1% 42.1% 53.2% 54.4% 50.2% 1.6 1.8 1.4 2.4 2.0 2.1 2.0 2.5 1.9 3.2 2.6 3.3 $ (281) $ (357) $ (374) $ (392) $ (247) $ (247) 2.0 2.4 1.8 3.4 2.4 2.7 8.9 9.7 13.5 10.3 8.5 7.9 10.1% 10.2% 16.5% 9.7% 16.1% 4.4% 5.7% 6.2% 11.2% 9.5% 16.3% 9.3% 15.1% 4.5% 5.5% 6.3% 12.0% 9.8% 12.3% 9.5% 16.0% 4.5% 5.5% 5.9% 3.7% 8.3% -4.9% 3.4% 11.3% 4.5% 5.8% 6.1% -0.5% 8.3% -3.4% 6.6% 8.1% 4.4% 6.1% 6.4% 1.5% 8.1% -2.5% 5.4% 10.8% 3.8% 6.3% 6.3% Source: Company reports, Reuters & WTR estimates. *2007 data for year-end 2006. Between November 2004 and October 2006, eight suppliers with at least $0.4 billion in annual revenue filed for bankruptcy protection (see Figure below). Several in the group have made progress to exit from court protection, most notably, Delphi Corporation (DPHIQ.PK: NR), the largest and former in-house supplier to General Motors. Delphi hopes to reemerge by year-end 2007. The restructuring of the troubled suppliers should provide opportunities for the healthier companies to pickup new business or acquire unwanted subsidiaries. Thus far, most of the buying has been done by the private equity sector. -10- Auto Supplier Update Industry Note Supplier Chapter 11 Filings Customer Mix Company Amcast Collins & Aikman Dana Corp. Delphi Dura Automotive J.L. French Meridian Tower Automotive Filing Date Nov-04 May-05 Mar-06 Oct-05 Oct-06 Feb-06 Apr-05 Feb-05 Revenue $0.4 billion $4 billion $10 billion $27 billion $1 billion $2 billion $1 billion $3 billion GM 34% 22% 11% 54% 32% 10% 32% 10% 32% 19% 32% 35% 17% 9% 17% 19% 25% 25% 28% 8% Ford DCX Source: Company reports & WTR estimates The 8 stocks in the Supplier Comp Sheet are currently valued at 11.9 times expected 2008 earnings on a P/E basis, about 10% higher than the average valuation at a comparable time over the last three years. On an EV/EBITDA basis, the group is trading at 6.7 times trailing EBITDA compared with an average of about 5.4 times at this point over the last three years. The group remains at a premium despite coming down by more than 10% over the last few months, reflecting heightened concerns over the direction of the North American sales cycle. The Figure below looks at the monthly group EV/EBITDA multiples since 2004 with the September data reflecting the most recent prices. As can be seen in the chart, valuations have moved lower since the peak levels in June, but multiples remain higher than any comparable data. On the P/E side, multiples have backed off the June levels, but remain higher than recent comparisons. An updated Supplier Comp Sheet is provided at the end of the text, the table provides financial metrics for each of the 8 companies in our group. Supplier Group Valuation - Trailing EV/EBITDA 8.0 7.5 7.0 6.5 6.0 5.5 5.0 2004 4.5 Jan Feb Mar Apr May Jun Jul Source: Company reports, Reuters & WTR Aug Sep Oct Nov Dec 2005 2006 2007 Investment Summary On average, consensus estimates for the supplier group are expected to double in the second half versus the 2006 comparison, and increase 15% in calendar year 2008, -11- Auto Supplier Update Industry Note despite flat industry builds in North America. The aggressive expectations, in our opinion, could lead to further multiple compressions for the group over the coming months as more realistic earnings assumptions are discounted by the market. As a result, we remain cautious on the auto supplier sector owing largely to valuation and our belief that the news toward the group will remain negative. The accelerated weakness in U.S. light vehicle sales over the last few months as well as the market share erosion at the Detroit Three, in our opinion, will likely pressure financial performance for the group into 2008. We believe the best way to play the group is to look for a sell-off in one of the suppliers with lower exposure to the North American market as well as the Detroit Three. American Axle (AXL: Hold) Current price: $21.17 Target Price: $22 EPS Estimates: CY 2007: $1.55 CY 2008: $1.70 Valuation assumption: traditionally, the supplier group has traded at 10-15 times earnings on a P/E basis and 4.5-6.5 times trailing using the EV/EBITDA metric. We believe AXL deserves credit for the restructuring success over the past ten years, product leadership and solid management team. However, its dependence on GM and the light truck side of the business, in our opinion, supports our group multiple for the stock. Our target price of $22 per share reflects a 13.0 multiple on our 2008 earnings assumption of $1.70 per share. Investment Highlights: AXL is at the center of several negative variables that are affecting the entire group, including: lower volume levels in its key product segments; raw material cost inflation; and the continuation of pricing pressures from the vehicle manufacturers. Rear-wheel drive light trucks in North America account for about 85% of total company revenue. The vehicles accounted for 28% of U.S. light vehicle sales in 2006, down more than two points from 2005, and about five points lower than the peak levels in 2004. The combination of falling demographics, substitute products and unstable gas prices has taken a toll on demand levels for the vehicles. AXL has been winning new business away from the full-sized segment, but the weakness should continue to pressure performance into 2008. A potential positive catalyst for AXL could come from an improved labor deal in early-2008. In late-2006, the company announced that 1,500 employees had accepted an early retirement buyout, which should allow a reduced cost structure going forward, and in early-2008, its contract with its key unions are up for renewal. Borg Warner (BWA: Hold) Current price: $83.34 Target Price: $77 EPS Estimates: CY 2007: $4.80 CY 2008: $5.40 Valuation assumption: traditionally, the supplier group has traded at 10-15 times -12- Auto Supplier Update Industry Note earnings on a P/E basis and 4.5-6.5 times trailing using the EV/EBITDA metric. We believe BWA's financial record, balance sheet, its ability to generate cash, and its competitive position justify a premium to the supplier group. A 10% premium on a P/E multiple of 13 for the group produces a target price of $77 per share based on our $5.40 per share estimate for 2008 (13 group multiple X 110% X $5.40 per share). On an EV/EBITDA basis, BWA is currently valued at 8.5 times trailing earnings, about a 27% premium to the group. Investment Highlights: BWA has been positioned in the right place at the right time for the move to smaller more efficient engines globally, the growth in automatic transmissions, the increased requirements for emissions, and until recently, the move to four-wheel drive vehicles in North America. Going forward, we believe the company is among the best positioned global suppliers to capture growth from a move toward a cleaner drivetrain. The performance drivers have been and, in our opinion, will continue to be, revenue growth, strong margins, and cash generation. BWA, in our opinion, has been the most aggressive with earnings guidance and in the past has been among the first to scale back expectations when industry conditions shifted. We view the stock as expensive at current levels, but lower-than-expected industry production in North America could lead to reduced guidance and an opportunity to buy the stock on weakness. Johnson Controls (JCI: Hold) Current price: $108.94 Target Price: $105 EPS Estimates: FY 2007: $6.25 FY 2008: $7:00 Valuation assumption: since the acquisition of York in late-2005, the market seems to have valued JCI at a blended multiple with the auto suppliers and the controls segment. Our target price is based on a blended P/E valuation of 15.4 times 2008 estimates, and an EV/EBITDA multiple of 9.3 times trailing performance. Both metrics are a significant premium to the supplier group. Investment Highlights: The combination of consistent revenue and earnings growth, its ability to generate cash, and its diverse list of customers, in our opinion, has always placed JCI in a unique position in the supplier universe. The acquisition of York only enhances JCI's position. Despite the eroding conditions in the North American auto sector, JCI has been able to post double-digit earnings growth in three of the last four years, and should post double-digit gains once again this year and next. JCI will host the financial community in New York on October 9th. The company is expected to provide guidance for 2008. Any backlash to the supplier group at the conclusion of current labor talks with the vehicle manufacturers could provide a buying opportunity heading into the annual investor meetings in NY. -13- Auto Supplier Update Industry Note Lear Corporation (LEA: Hold) Current price: $27.55 Target Price: $35 EPS Estimates: CY 2007: $2.30 CY 2008: $2.80 Valuation assumption: traditionally, the supplier group has traded at 10-15 times earnings on a P/E basis and 4.5-6.5 times trailing using the EV/EBITDA metric. On a P/E basis, LEA's dependence on light trucks, debt levels and its concentration of revenue with the Big Three will likely keep the equity valued at a discount to the Supplier Group. Our $35 per share target assumes a 5-10% discount for Lear. Investment Highlights: In the past, Lear's position with content on light trucks, its ability to generate cash, and its focus on the interior side of the business were all cited as positives for the stock and justified a premium to the group. The consumer's movement away from full-sized SUVs and mixed financial performance, in our opinion, are now concerns. The company benefited as much as any supplier from the acceleration of large light trucks in the 1990s and has been hit harder as volume levels for the trucks has declined. LEA has been actively restructuring the company, it has divested its interior business, and margins have been improving steadily in the key seating segment. Lear's new business backlog has slowed going forward, largely the result of lost business with the Detroit Three, the timing of the awards calendar, and a conservative industry forecast. However, growth at Lear has been constrained and is a concern going forward. Excluding the deal for Chrysler, private equity firms have completed about three dozen acquisitions in the automotive sector over the last two years, investing over $20 billion in the sector. Despite shareholders rejecting a $37.25 per share bid for Lear, the private equity activity, in our opinion, will keep buyout speculation active for Lear over the coming months, especially if the debt markets begin to stabilize. TRW Automotive (TRW: Hold) Current price: $29.30 Target Price: $34 EPS Estimates: CY 2007: $2.30 CY 2008: $2.45 Valuation assumption: traditionally, the supplier group has traded at 10-15 times earnings on a P/E basis and 4.5-6.5 times trailing using the EV/EBITDA metric. TRW's broad regional revenue base and customer mix along with its diverse product lineup and its position to capitalize on the growth of vehicle safety justify a premium valuation for the stock, but debt levels and the overhang from Blackstone's ownership (currently about 46%) should bring levels closer to the group average. A group multiple on our $2.45 per share estimate for 2008 suggests a target price of $32 per share (13.0 group multiple X $2.45 per share) and on an EV/EBITDA basis, a more normal group multiple of 5.5 times our 2008 EBITDA forecast and a 10% discount for TRW (debt levels) suggests an enterprise value of $6.2 billion. Taking out the company's net debt level of $2.4 billion leaves an equity value of about $37 per share. An average of the two metrics produces a target price of about $34 per share. -14- Auto Supplier Update Industry Note Investment Highlights: TRW is a leader in braking, steering, occupant restraint, and engine components, supplying most of the vehicle manufacturers on a global basis. The company enjoys one of the broadest mixes of products in the supplier universe, as well as one of the more diverse lists of customers. Negatives include: debt levels, ownership overhang, and industry trends. On June 4, 2007 TRW completed a secondary offering of 11 million shares owned by Blackstone Investors, reducing its ownership stake from 56% down to 46% and greatly improving the float of TRW's stock. TRW's exposure outside of North America largely accounts for its seasonal weakness in the second half. The lower-than-expected build rates in the fourth quarter could lead to a scale back in expectations. Visteon (VC: Hold) Current price: $4.88 Target Price: $6 EPS Estimates: CY 2007: ($3.00) CY 2008: ($1.55) Valuation assumption: traditionally, the supplier group has traded at 10-15 times earnings on a P/E basis and 4.5-6.5 times trailing using the EV/EBITDA metric. Given the uncertainties at Visteon, the task at hand, and its debt levels, we expect the company to be valued at the low end of the group. The low-point of the historical supplier group range produces a total enterprise value of $1.6 billion based on our 2007 forecast ($400 million X 4.0 times multiple). Visteon currently has net debt outstanding of $1.23 billion, and we believe the company will end the year with about $1.3 billion of net debt, leaving about $2.30 per share for equity value. While our current forecast suggests some downside to current trading levels, we believe the stock will be constrained to a trading level between $4 and $8 per share owing to the headline risks in the industry, the market share woes at Ford, the scope of the task for Visteon, the ownership stakes in its Asian partners, and the consistent buyout speculation. Investment Highlights: Since 2000, Visteon has more than doubled its revenue from non-Ford customers, reaching $6 billion in 2006, but at the same time business with Ford has been declining. The ACH transactions with Ford in late-2005 transferred 23 North American production facilities, along with 18,000 leased hourly employees, and certain other assets and liabilities to Automotive Components Holdings, a wholly-owned subsidiary of Ford. The assets generated $6.1 billion in revenue in 2005, mostly to Ford, greatly reducing Visteon's reliance on Ford. In the first half of 2007, Ford accounted for about 44% of total company revenue, well below the 85% level of 2000. VC has made progress on its restructuring, but industry weakness and pricing pressures could make the hole deeper and more difficult to climb. VC has $1 billion of net new business coming on stream over the next three years, the cash from the Ford transactions should largely fund the transformation process, and ownership in its Asian ventures should provide some downside support for the stock. Risks The auto sector is capital and labor intensive, highly competitive, cyclical, and low -15- Auto Supplier Update Industry Note growth. An unexpected swing of industry conditions, in either direction, could lead to material changes in profit expectations. We base our forecasts on data from sources that are believed to be reliable, but are always subject to change given the nature of the auto sector. Higher-than-expected industry production levels would result in better-than-expected financial performance and could alter our investment opinion. -16- Ward Transportation Research Auto Supplier Comp Sheet Company Ticker Closing Price 09/11/07 Equity Valuation Market Capitalization (mil) Market Cap/Revenue P/E ratio - trailing 4q P/E ratio - 07 Consensus P/E ratio - 08 Consensus EV/EBITDA Book Value Price to Book Dividend Yield Debt Ratios Net Debt/Invested Cap Net Debt/EBITDA Total Debt/EBITDA Pension Status * Net Debt + Pension/EBITDA EBITDA/Interest Financial Performance Revenue Growth (12-mos) EBITDA Margin EPS Growth - trailing EPS Growth - 2006-07 EPS Growth - 2007-08 ROIC Return on Avg Equity Cap Exp/Revenue Inventory/Revenue SG&A/Revenue Amer Axle AXL $21.35 Autoliv ALV $56.47 B. Warner BWA $83.34 JCI JCI $108.94 Lear Corp. LEA $27.55 Magna MGA $88.00 TRW Auto TRW $29.30 Visteon VC $4.84 Average 1,127.2 35.2% 23.0 12.6 10.4 5.2 $15.88 1.3 2.8% 4,495.3 70.6% 12.2 14.5 12.4 7.2 $30.55 1.8 2.8% 4,909.4 100.1% 19.8 17.3 14.6 8.5 $33.75 2.5 0.8% 21,788.0 64.5% 18.7 16.0 14.5 10.9 $40.31 2.7 1.2% 2,151.7 12.7% 14.6 8.7 8.7 4.4 $9.77 2.8 nm 9,856.0 39.5% 13.1 11.4 11.2 4.8 $68.50 1.3 1.1% 3,029.6 22.3% 16.7 12.6 11.2 5.2 $23.34 1.3 nm 627.8 5.5% nm nm nm 7.2 ($0.80) nm nm 5,998.1 43.8% 16.9 13.3 11.9 6.7 $27.66 2.0 1.7% 37.6% 1.6 2.7 (95.1) 1.9 6.0 29.2% 1.3 1.5 (29.9) 1.4 13.9 18.8% 0.7 1.0 (125.4) 0.9 16.1 34.8% 1.8 1.9 (591.0) 2.1 8.7 69.5% 2.1 2.7 (287.3) 2.4 4.3 nm nm 0.5 (50.0) nm nm 52.5% 2.5 2.7 229.0 2.3 4.6 nm 4.7 10.4 (828.0) 7.9 1.5 40.4% 2.1 2.9 (222.2) 2.7 7.9 -6.1% 9.9% -14.7% nm 21.2% 5.6% 5.3% 6.4% 6.9% 6.3% 5.6% 12.0% 23.3% -20.1% 16.7% 12.3% 15.8% 5.2% 8.4% 5.5% 10.9% 12.8% -5.8% 19.9% 18.0% 11.1% 12.7% 5.0% 8.7% 10.3% 9.0% 7.1% 19.5% 29.8% 10.7% 11.0% 15.2% 2.6% 5.8% 9.6% -5.4% 5.4% 339.5% nm 0.0% 7.1% 7.8% 1.4% 3.3% 3.6% 5.6% 7.0% -5.0% 26.9% 1.8% 11.1% 9.9% 2.8% 6.3% 5.6% 5.4% 8.3% -32.4% 11.0% 12.4% 7.4% 9.1% 4.1% 6.2% 3.9% nm 2.3% nm nm nm nm nm 3.0% 4.6% 5.8% 3.6% 8.1% 46.4% 13.5% 11.6% 9.4% 10.8% 3.8% 6.3% 6.3% Source: Company reports and WTR estimates. AXL:Sell; ALV: NR; BWA: Hold; DCN: NR; DRRA: NR; JCI: Hold; LEA: Hold; MGA: NR; TRW: Hold; VC: Hold Note 1: All data adjusted for a fiscal year ending December. Note 2: Pension data represents latest available information. Michael P. Ward Ward Transportation Research -17- Auto Supplier Update Industry Note Regulatory Required Disclosures Analyst Certification I hereby certify that the views expressed in the foregoing research report accurately reflect my personal views about the subject securities and issuer(s) as of the date of this report. I further certify that no part of my compensation was, is, or will be directly, or indirectly, related to the specific recommendations or views contained in this research report. By: Michael P. Ward SOLEIL SECURITIES DISCLOSURE INFORMATION ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST Soleil Securities Corporation, in order to provide its clients with research independent from investment-banking conflicts, has contracted with the publisher and/or author of this report. Soleil Securities Corporation does not provide investment banking services. The author of this report is compensated by Soleil Securities Corporation by receipt of a share of commissions paid to Soleil by customers crediting the author for their order(s). Soleil Rating Key: Buy: In the analyst's opinion, the stock will outperform the general market over the next 12 months. Hold: In the analyst's opinion, the stock will be inline with the general market over the next 12 months. Sell: In the analyst's opinion, the stock will underperform the general market over the next 12 months. Soleil Securities Distribution of Ratings/IB Services Firmwide and by Sector Capital Goods/Industrials IB Serv./Past 12 Mos. IB Serv./Past 12 Mos. Rating BUY [BUY] HOLD [HOLD] SELL [SELL] Count 158 127 26 Percent 45.40 36.49 7.47 Count 0 0 0 Percent 0.00 0.00 0.00 Rating BUY [BUY] HOLD [HOLD] SELL [SELL] Count 1 6 2 Percent 11.11 66.67 22.22 Count 0 0 0 Percent 0.00 0.00 0.00 ADDITIONAL DISCLOSURES INFORMATION Soleil Securities Corporation: The opinions, forecasts, and recommendations contained in this report are those of the analyst preparing the report and are based upon the information available to them as of the date of the report. The analysts are basing their opinions upon information they have received from sources they believe to be accurate and reliable and the completeness and/or accuracy is neither implied nor guaranteed. The opinions and recommendations are subject to change without notice. Soleil Securities Corporation has no obligation to continue to provide this research product and no such obligation is implied or guaranteed. The report is provided to the institutional clients of Soleil Securities Corporation for informational purposes only and is not an offer or a solicitation for the purchase or sale of any financial instrument. Price/Performance Charts for all Rated Stocks mentioned in this report are available from: Soleil Securities Corp. 360 Madison Avenue - New York, NY 10017 - 212.380.4800. For further discussions of risks and valuations pertaining to the above-mentioned rated companies with price targets, please see our latest reports on these individual companies, available by contacting the analyst at the address/phone number above. Companies Mentioned -18- Auto Supplier Update Industry Note American Axle & Manufacturing Holdings (AXL, $21.88, Hold , NYSE) BorgWarner (BWA, $83.34, Hold , NYSE) Ford Motor (F, $7.58, Sell , NYSE) General Motors (GM, $30.54, Sell , NYSE) Genuine Parts (GPC, $48.58, Buy , NYSE) Johnson Controls (JCI, $108.94, Hold , NYSE) Lear (LEA, $27.55, Hold , NYSE) TRW Automotive Holdings (TRW, $29.30, Hold , NYSE) Visteon (VC, $4.90, Hold , NYSE) Autoliv (ALV, $56.58, NR, NYSE) Delphi Corporation (DPHIQ.PK, $0.60, NR, OTC) Honda Motor (HMC, $32.61, NR, NYSE) Magna International (MGA, $88.01, NR, NYSE) Nissan Motor (NSANY, $18.92, NR, Nasdaq) Toyota Motor (TM, $113.25, NR, NYSE) Additional Disclosures -19-