Automotive Stocks to Buy After Volkswagen's Emissions Scandal

U.S. car sales are rising, especially for bigger cars and sport-utility vehicles, spurred on by cheap gasoline and relaxed lending standards. And as scandal overshadows Volkswagen, the world's largest automaker, U.S. auto manufacturers look even more appealing, analysts say.

U.S. motor vehicle sales jumped in August to a seasonally adjusted annual rate of 17.8 million, from 17.6 million in July, industry data shows.

Pat O'Hare, chief market analyst at Briefing.com, says Americans are more interested in buying cars as they feel better about the economy, and auto lenders are more willing to extend the terms at which they offer vehicle loans.

Combined with cheap gasoline, "it's been a pretty good general backdrop, if you will, for this significant pickup in auto sales that we've seen," he says.

Yet the share prices of big automakers like General Motors Co. (ticker: GM) and Ford Motor Co. (F) are down dramatically this year. Much of that has to do with concerns about the global economy, despite strong U.S. car sales. Eurozone car sales are up, but Chinese car sales are softening.

This weakness makes GM and Ford stock attractive, says David Whiston, equity strategist at Morningstar, a Chicago-based investment research company. "GM and Ford, their stocks aren't where they should be. There are concerns about China, the size of their pension obligations ... There's a lot of bias against the auto industry, especially the U.S. automakers in the stock market. It's not all deserved," he says.

Furthermore, Whiston points out that GM and Ford are paying "outstanding" dividends greater than 4 percent, outperforming the 2 percent dividend yield of the Standard & Poor's 500 index and 10-year Treasury notes.

O'Hare says the strong dividends make them attractive for "conservative-minded investor more interested in picking up dividend income versus capital return."

Beware of Volkswagen. In non-U.S. car manufacturers, troubled Volkswagen (VKLAY) is down 40 percent so far this year as the company suffers a black eye from its rigged diesel engine emission tests in the U.S. and Europe. The company said 11 million of its cars worldwide were impacted, and its chief executive officer stepped down because of the mess. Although Whiston doesn't cover Volkswagen as part of his research, generally he says there could be a buying opportunity at some point for VKLAY stock.

"The thing is, there will be all these overhangs on the stock" because of the scandal, he says. Not only will the company have to reach an agreement with the U.S. government, it's highly likely there will be civil litigation, which will mean even more money spent by the company.

Settlements take time, too. For example, GM paid $900 million in September to settle criminal charges related a recall about defective ignition switches. In February 2014, GM admitted it did not tell regulators what it knew about the bad switches. These switches could cause vehicles to stall and cut power to air bags.

Deutsche Bank analysts recall a 1987 case from Germany automaker Audi (AUDVF) about sudden-acceleration incidents and a resulting lawsuit in the U.S. It "can take up to 10-plus years before selling volumes reach previous peaks again. Back in the day Audi suffered a massive loss in reputation and this wasn't even about cheating," analysts wrote in a research note.

Fallout for suppliers. As Volkswagen's scandal made headlines, auto parts suppliers were hit in the aftermath. O'Hare says BorgWarner (BWA) and Delphi Automotive (DLPH) derive at least 10 percent of their sales from Volkswagen. Even platinum prices fell because the precious metal is used in diesel engines for pollution control.

"When something like that breaks, it's a guilty-until-proven-innocent association as it relates to peer companies. We know Volkswagen is guilty; they admitted to it. The fear is that potentially other automakers are engaged in similar practice. ... People sell first and ask questions later," O'Hare says.

While anything is possible regarding fallout from the Volkswagen scandal, sometimes companies get unduly punished. Before the news, a number of auto suppliers were trading at a fair value, so this might be time for investors to see how these stocks could fit in their portfolio, if they are willing to ignore headlines. Several suppliers are benefiting from higher U.S. car sales, Whiston says.

One to consider is Johnson Controls (JCI), Whiston says. The company, which has paid consecutive dividends since 1887, is planning to spin off its automotive division but keep its heating, ventilation and air-condition unit and battery group, he says. Johnson Controls is the global leader in lead-acid battery manufacturing and is the top producer of the newer absorbent glass mat battery, which is used with "stop/start" technology in cars. That technology turns off cars when they come to a red light, but keeps the other systems in the car running, like the radio and heat. That technology helps with fuel efficiency, he says.

Improvements with fuel efficiency are critical for cars as the new fuel economy standards set by the Department of Transportation mean that by 2025, the car fleet must reach 54.5 miles per gallon.

Two other auto parts suppliers to consider are Swedish safety-parts manufacturer AutoLiv (ALV), which Whiston calls "very shareholder friendly, [although] not undervalued right now."

Genetix (GNTX), which makes auto-dimming mirrors, is Whiston's second pick. "They have 80 percent of the market share of auto-dimming. ... Their margins more like a technology company. They also make auto-dimming windows for Boeing [BA]," he says.

O'Hare says investors with a long-term approach may see value in building a small position in these companies.

"Take stock of how the global economy is unfolding. ... If there is confidence restored to the ideas the U.S. is pulling up the global economy versus the global economy pulling us down, if that narrative is restored and data backs it up, these stocks will come back onto favor," he says.