Autonomous vehicles can drive rich returns for these stocks down the road

Tech companies and auto parts suppliers are a great way for investors to profit from the driverless car trend.

Vikram Barhat 26 January, 2016 | 6:00PM
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It only takes a quick Google search for "self-driving cars" to know how close we are to the reality of driverless vehicles. A fantasy conjured up in many sci-fi films, intelligent cars are now routinely paraded at consumer shows. Automakers Audi, Mercedes-Benz and Tesla, as well as tech giants Google and Apple, are all betting on these vehicles with ongoing projects and testing prototypes.

Some tech firms are hastily joining hands with auto manufacturers, others quietly innovating, in a race to capture a large slice of what is expected to become a US$50 billion market over the next decade, according to French bank Exane BNP Paribas. In fact,  Toyota Motor Corp. (TM) has already disclosed its plans to have self-driving vehicles available for sale by 2020.

A great way for investors to play this market in the long term is to buy tech companies and parts suppliers that are making components -- sensors, chips, cameras and communications devices -- that will enable vehicles to function autonomously in real-world conditions. At the forefront of autonomous vehicle technology, these companies could be big winners when the self-driving car market takes off. Moreover, these companies have diversified product ranges which will continue to drive future growth and profitability, according to Morningstar equity research.

Magna International Inc.
Ticker MG
Current yield 2.28%
Forward P/E 5.9
Price $49.82
Fair value $54
Data as of Jan. 22, 2016

Canadian auto parts supplier  Magna International Inc. (MG) provides carmakers a wide range of products including exteriors, interiors, seating, body and chassis, and vision and electronic systems. The company, whose customers include General Motors, Volkswagen, BMW and Ford, also assembles vehicles under contract.

Magna is well-positioned to commercially exploit the self-driving vehicles theme, according to a Goldman Sachs report, as the world's fourth largest supplier of advanced driving assistance systems (ADAS), a technology that boosts safety through cameras and collision-warning systems needed for self-driving cars. The firm has a number of sensing technologies including rear cameras and ultrasonic sensors -- key components for vehicle automation.

"The company generates innovations, possesses long-term highly integrated customer relationships, and has wide product breadth,” said Morningstar equity analyst Richard Hilgert in a report.

Magna recently announced that it had reached an agreement to acquire Getrag, one of the largest independent producers of vehicle transmissions. The transaction, which prompted Hilgert to raise the stock's fair value from $47 to $54 last summer, formed the basis for Magna to forecast a 15.7% jump in its auto parts manufacturing business in 2016.

International Business Machines Corp.
Ticker IBM
Current yield 4.08%
Forward P/E 7.5
Price US$122.50
Fair value US$145
Data as of Jan. 22, 2016

 IBM Corp. (IBM) is a leading IT company whose product offering includes system hardware, infrastructure software, outsourcing and systems integration services. As a market leader in real-time monitoring systems, complex event processing, predictive analytics and real-time traffic analysis and updates, IBM has a lot to contribute to, and gain from, the market for self-driving vehicles.

Earlier this month, Ford and IBM teamed up to develop a pilot platform, the Ford Smart Mobility Experimentation Platform, that analyzes vehicular data to find a parking spot or detect a traffic jam, useful features in autonomous vehicles. In fact, IBM has published a white paper entirely around how a driverless car works.

Despite challenges, IBM's profitability has steadily improved through cost reductions and a shift toward software and higher-value services, said a Morningstar equity report.

"With more than 60% of IBM's software revenue considered annuity-like or recurring today, plus strategic plans to increase its exposure to higher-margin (and higher-growth) software businesses including cloud and analytics, the firm's competitive position in the software arena appears both sizable and defensible," said Morningstar strategist Rick Summer, who put the stock's fair value at US$145.

Texas Instruments Inc.
Ticker TXN
Current yield 2.78%
Forward P/E 13.6
Price US$50.30
Fair value US$57
Data as of Jan. 22, 2016

 Texas Instruments Inc. (TXN) designs and makes semiconductors and sells them to electronics designers and manufacturers.

TI stands to benefit from the push into driverless cars as a leading manufacturer of system-on-chip (SoC) processors. Designed for self-driving cars, these processors are instrumental in vision analytics and a range of safety-critical applications such as surround view, lane assist, traffic sign recognition and object detection.

The chipmaker gained 44% of its 2014 revenue from the automotive and industrial end markets, according to a Morningstar equity report. The long product life cycles and high profitability associated with product designs means the firm will continue to generate robust profitability over the next 20 years, said the report.

A positive outlook for the firm's growth prospects prompted Morningstar sector director Brian Colello to peg the stock's fair value at US$57. "TI's embedded chip business may also see healthy growth over the next few years, especially if the Internet of Things trend takes off," he said. "TI's microcontrollers, Wi-Fi and Bluetooth chips could be key components in a massive array of new electronics devices with improved connectivity and processing power."

Skyworks Solutions Inc.
Ticker SKWS
Current yield 1.16%
Forward P/E 9.5
Price US$67.03
Fair value US$92
Data as of Jan. 22, 2016

 Skyworks Solutions Inc. (SWKS) produces semiconductors that enable wireless connectivity. Skyworks' customers are mostly leading smartphone manufacturers, including  Apple (AAPL) and Samsung, but the firm also has a growing presence in non-handset applications.

The firm's semiconductors and chips are used for radio frequency (RF) and mobile communications systems, technology that will enable autonomously driving vehicles to self-correct while in motion.

"We're highly encouraged by Skyworks' diversification into non-handset end markets, especially as connectivity is becoming more ubiquitous in other industries such as automotive," said Colello. He adds, however, that "the company's fortunes will remain tied to the wireless industry for quite some time," from which it earns more than 70% of its revenue.

Given the rise of advanced 4G LTE-enabled smartphones, which use a wider variety of wireless spectrum and frequency bands, there's "a nice runway for further RF growth for Skyworks," said Colello, who considers the stock worth US$92.

The company is a leading RF supplier to other industries, such as industrial, medical and networking and wireless infrastructure equipment. "In these industries, Skyworks appears to be profiting from longer product life cycles and steadier pricing," added Colello who forecasted organic revenue growth of 14% in 2016 and 12% in 2017.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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