Regulation maintains sales of aftermarket OE parts and services

Chako Ando (Nihon Equity Research) submits: These have been flush times for Japan's auto industry. Toyota (TM) is now the biggest auto company in the world, Japanese makers continue to gain share in the U.S., high oil prices are boosting the sale of Japan's energy-efficient cars, and, as the worldwide auto market continues to expand, the cheap yen aids profits. 2007 should be another banner year for Japan's auto industry.

But finding value among Japanese auto stocks is difficult. The big names like Toyota, Honda (HMC), and Nissan (NSANY) are widely followed and very likely fully priced. Goldman recently released new target prices for Honda and Nissan, but as Steven Towns has commented, there's no excitement, as actual prices are around (or, now, above) target prices.

Focus has thus begun to turn to the auto parts and manufacturing equipment industry. However, according to S&P Japan's classifications, there are some 122 publicly traded auto parts/equipment companies in Japan. There are big, well-known names like Denso (JP: 6902) (DNZOY.PK), a Toyota keiretsu major parts manufacturer with over $30 billion in market cap (about the same as Ford (F) and GM (GM) together). But many are small firms; some are microcaps. A majority of the companies have no analyst coverage.

Mizuho Securities recently released a report on this industry. Among the major upgrades were Koito (JP: 7276), an automotive lighting manufacturer; Tokai Rika (JP: 6995); and Denso. Nihon Securities Journal recently recommended Nisshinbo (JP: 3105): while only 20% of sales are auto parts, they account for the bulk of operating profit, which grew 28% for the segment in the March 2007 year (according to a Reuters article dated May 23, Steel Partners has about a 5% stake).

Among much less well-known companies is H-One (JP: 5989), a new name as a result of a merger of two Honda group parts companies. Year-over-year sales and net profit comparisons (plus 211.9% and 167.3%, respectively) aren't useful because of the merger, but other measures seem to indicate that the combination resulted in some improved ratios (per share profit is up 64.4%, ROE improved from 7.6% to 14.7%). Trading at a (historical) P/E of 9, the company might be good value for small-cap investors who believe Honda will continue to grow in the world's marketplace (90% of H-One's sales come from Honda).