The auto industry has traditionally been highly sensitive to economic cycles, so its production rates and financial condition have commonly been described as swinging between feast and famine extremes. But the famine that the auto industry has endured in the past two years has been especially harsh. Indeed, a Barron’s reporter tweaked that metaphor further and observed that the industry has largely been on a starvation diet throughout 2008 and 2009.

Consider these gnawing particulars:

*  Almost all automotive companies lost money in 2009.

*  General Motors and Chrysler declared bankruptcy.

*  Worldwide auto production shrunk 18% from a peak of 70.4 million in 2007 to 58.0 million in 2009, according to J. D. Power and Associates.

*  In the United States, the number of cars on the road decreased by 2% in 2009, as more cars were scrapped than new cars were sold to replace them, according to The New York Times. Such a decline is highly unusual -- the first since World War II. Altogether, domestic sales of new cars in 2009 plummeted 44% from their high point in 2000.

*  Albert A. Koch, the consultant who led the restructuring of General Motors after its bankruptcy, said that things looked so precarious during the financial crisis in late 2008 that the entire auto industry was perilously close to shutting down for months or even years.

Better times ahead

But we think the auto industry’s starvation diet is about to end. In our view, we think notably better times, if not exactly a feast, are ahead for the industry. Auto production should start to pick up this year as the global economy continues to expand, as an increasingly aging fleet of cars in the developed countries are replaced, as tight inventories are replenished, and as pent-up demand materializes, especially in the developing countries.

We concur with projections that auto production around the world may gradually reach double-digit annual growth rates over the next 24 months. J.D. Powers and Associates estimates that year-over-year production will increase by 5.7% in 2010, to 61.3 million vehicles, and by 13.5% in 2011, to 69.6 million vehicles.

Many of those cars are likely to be made or sold in China, which has been the notable exception to the recent famine tale in the auto industry. China has been the fastest-growing auto market, so much so that in 2009 it gained the distinction of becoming the world’s biggest market in sales as well. We think Chinese auto sales could easily climb by 50% in 2010 over last year. China’s 1.3-billion citizens drive about 35 million cars, and the McKinsey Global Institute expects that fleet to grow to 120 million by 2020. We think demand from China, India, and other developing nations should contribute to increased auto production for years to come, to a total of 88.3 million vehicles being produced worldwide by 2016, an increase of 44% from the level of 2010, according to J. D. Powers.

In our view, as production rises, it could significantly improve the fundamentals of select materials/processing companies in the aluminum, chemical, platinum, and steel industries that are major suppliers to the auto industry.

Among the greatest beneficiaries are likely to be aluminum and chemical companies, whose products are being increasingly used in vehicles. Automakers are favoring aluminum and plastics for their light weight and technical characteristics, which are helping to improve the fuel economy, safety, and performance of vehicles. The fourfold increase in aluminum and plastics content per car since 1970 has largely come at the expense of steel, although the amount of steel used still surpasses that of either aluminum or plastics. The average North American car contains about 2,500 pounds of steel and iron, about 326 pounds of aluminum, and about 300 pounds of plastics, according to Automobile Magazine.

All told, we think rebounding auto production in 2010 and 2011 could translate into increased business for these eight leading materials/processing companies, among others:

*  In the aluminum industry, Alcoa (market capitalization: about $15.5 billion, headquarters: Pittsburgh) may profit the most from any pickup in auto production. We estimate that more than 30% of aluminum demand is tied to the auto industry, to the potential benefit of Alcoa, the world’s largest aluminum producer. Alcoa, with its Auto and Truck Structures unit, is especially well-positioned to serve the auto industry, providing bumpers and chassis components such as engine cradles, wheel carriers, frames and frame parts, and suspension parts. The company’s products have enabled automakers to trim as much as 33% of the weight from those components.

*  In the chemical industry, we think PPG Industries (market capitalization: about $9.8 billion, headquarters: Pittsburgh) and Solutia (market capitalization: about $1.5 billion, headquarters: St. Louis) could do well.

PPG Industries has a growing market share in coatings and derives about 14% of its revenue from the auto industry. It also supplies chemicals, adhesives, and sealants. PPG is the leading supplier of coatings to the Japanese automakers’ plants in the U.S. and to Fiat and Renault plants in Europe. The company pioneered the process of applying a base coat to vehicles by dipping the chassis into a vat of paint, which is more economical than manual spray painting, the conventional method previously. PPG not only provides the coatings but in many cases applies them for the automakers at their plants.

About 60% of Solutia’s business is auto-related. The company is the world’s largest producer of polyvinyl butyral, which serves as the plastic interlayer in windshield glass. This interlayer makes possible glass with lower surface temperatures, lighter weight, and better visibility for drivers in the daytime. Polyvinyl butyral is used in about 50% of all automotive glass and for which the auto industry accounts for more than 80% of demand. Solutia also makes window films and chemicals used in producing rubber and tires. The company is a financial turnaround story: it declared bankruptcy earlier in the decade, but has remade itself into a smaller -- and we think, potentially more profitable -- company. Nylon has been Solutia’s core business, but it’s now being divested. With this divestiture, Solutia’s management foresees the company cutting its sales by 50% yet increasing its profit margins by 100%.

*  In the platinum industry, Aquarius Platinum (market capitalization: about $3.2 billion, headquarters: Hamilton, Bermuda) and Impala Platinum Holdings (market capitalization: about $18.8 billion, headquarters: Northlands, South Africa) are prime producers of a metal that’s a key element in the filters of catalytic converters, which reduce the toxicity of car emissions. The auto industry is by far the biggest customer for platinum, responsible for nearly 50% of the demand, in our estimation.

Over the years both Aquarius and Impala have felt the financial pinch when auto production slackens and savored the financial rewards when production bounces back. Aquarius produces about 456,000 ounces of platinum annually. (Platinum is so rare and precious that it’s typically accounted for in ounces by the industry, not in tons as with other metals. The annual global supply is only about 6 million ounces.) Impala is the low-cost producer of platinum, mining about 1.7 million ounces of the metal annually.

*  In the steel industry, AK Steel (market capitalization: about $2.3 billion, headquarters: West Chester, Ohio), ArcelorMittal (market capitalization: about $67 billion, headquarters: Luxembourg), and United States Steel (market capitalization: about $7.5 billion, headquarters: Pittsburgh) claim the biggest shares of the automotive market. About 22% of the orders for carbon steel and 15% of the demand for stainless steel come from the auto industry, according to Citigroup Global Markets. All three firms are integrated steel producers (they can perform all of the primary functions in making steel from scratch). As such, they possess greater operating leverage to a pickup in demand for steel and thus a potential for higher profits than their non-integrated competitors, the mini-mill companies such as Nucor and Steel Dynamics, do.

We estimate that the auto industry generates about 15% of annual sales for ArcelorMittal and United States Steel and about 30% of annual sales for AK Steel. And we think that demand for steel from the auto industry may rise by as much as 50% over the next 12 months.

AK Steel produces about 6 million tons of steel per year. The company is the leading maker of carbon and coated steel for the automotive market and stainless steel for automotive-exhaust systems. Its Black Coat stainless steel was developed to help automotive-exhaust systems withstand the high temperatures of modern engines and at the same time to improve the appearance of those systems.

ArcelorMittal is the world’s largest steel company, with annual production totaling 103 million tons, or about 10% of the world’s output. The company has the broadest geographical presence, with plants in more than 20 countries.

United States Steel has a production capacity of about 32 million tons. The company is filling more orders for Dual-Ten high-strength steel, which was developed expressly for automotive applications. Dual-Ten is lighter in weight than other steels, and its strength is a plus in reducing damage from vehicle collisions, so it’s being specified more frequently by automotive designers for use in the underbody and body panels of cars.

In sum, we think the anticipated increase in automotive demand for aluminum, chemicals, platinum, and steel should enhance the bottom lines of Alcoa, PPG Industries, Solutia, Aquarius Platinum, Impala Platinum Holdings, AK Steel, ArcelorMittal, and United States Steel over the next two years. In fact, we think their profits this year may rise to a greater extent than Wall Street expects, as the economic pendulum of the auto industry swings from famine towards feast.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm that manages more than $17 billion in stocks in separately managed accounts and mutual funds for institutions and individuals, as of December 31, 2009.

As of December 31, 2009, Turner held in client accounts 7.3 million shares of Alcoa, 110 shares of PPG Industries, 1.9 million shares of Solutia, 669,000 shares of AK Steel, 28,910 shares of ArcelorMittal, 830,920 shares of United States Steel, 1.3 million shares of Nucor, and 148,460 shares of Steel Dynamics. Turner held no shares of Aquarius Platinum and Impala Platinum Holdings.