With auto markets in North America, Europe and Japan mostly saturated, it is sales in emerging markets — where rising incomes are boosting car ownership — that is fuelling global growth in the auto sector.

Although this surge should suggest that companies with a strong presence in the developing world would be good investment bets, the fact is that most automakers and parts manufacturers do more business in the industrialized world. As a result, investors looking for opportunities in global auto markets need to focus on management, efficiency of operations and product lineups.

The best opportunities, according to a number of global money managers, include luxury automakers Dr. Ing. hcF Porsche AG and Bayerische Motoren Werke AG, both based in Germany; Japan-based Honda Motor Corp. and Korea-based Hyundai Motor Co. , which produce for the mass market in both the industrialized and developing world; and motorcycle and auto producer Suzuki Motor Corp. of Japan, which focuses on emerging markets.

Picks among auto parts makers include one small firm, Martinrea International Inc. of
Toronto, and three niche players — Germany’s Continental AG, which produces high-end tires and an electronic safety system; Neomax Ltd. of Japan, which makes a key component for hybrid cars; and U.S.-based BorgWarner Inc. , which produces
transmissions, transfer cases, clutches, torque converters and turbochargers.

A major theme in global auto markets is hybrid cars, which are 30%-40% more fuel-efficient and produce less CO2 emissions. Honda, along with Toyota Motor Corp. ,
pioneered hybrids, and sales have been very strong. Neomax makes a vital component for hybrids, for which it holds all the patents. As well, Porsche has formed an alliance with Volkswagen AG and Audi AG, both of Germany, to develop hybrid technology;
BMW, Germany’s DaimlerChrysler AG and Detroit-based General Motors Corp. are all working on hybrid technology.

Model lineup is a key factor for success, because manufacturers must have attractive models that consumers want.

Another factor is a focus on shareholder value. Most automakers are run for customers and employees rather than shareholders, says John DeVita, a principal at Connecticut-based Altrinsic Global Advisors and manager of CI Global Consumer Products Fund.
“Return on capital for almost every Western automaker has been dismal,” he says.
DeVita finds the best opportunities in Japan — companies such as Honda and Suzuki, which make good returns.

As for auto parts, investors want manufacturers that are active niches players or that provide products that are in demand. Companies that do well include those that make products with a high-tech component or that address safety issues, says DeVita.
Unfortunately, he finds most of the manufacturers’ stocks are too high-priced.
However, he says, it looks as if there will be some consolidation in the sector, which should reduce costs and could generate investment opportunities.

Here are nine investment picks:

> Porsche. The company has a very strong brand and a very successful new model lineup, says Charles Burbeck, head of global equities at HSBC Halbis Partners in London. Cayenne, its expensive sports utility vehicle, has done very well. The family-controlled company also keeps both its costs and capital requirements down by outsourcing much of its manufacturing. With no excess capacity, the company gets great profit margins.

Porsche recently announced it was raising its stake in VW to 20% from 5% to prevent hostile takeovers. Burbeck considers this “neutral to slightly positive.” Porsche already outsources production to VW.

> BMW and Honda. David Herro, chief investment officer of international investments at Chicago-based Harris & Associates and manager of AGF International Value Fund, likes these two firms for the same reasons. “Both earn very good returns compared with the industry — double-digit returns on capital employed of 12%-13%,” he says.
“Both have a decent dividend payout policy. Both are competitive, able to grow their businesses in a stagnant sector and continue to increase market share through new products that people want.”

Herro likes their approach to excess cash. “They don’t put it into ancilliary activities or keep it on the balance sheet,” he says. “Instead, they recyle it into new models, new geographical areas and new efficient automobile technology — and then give the rest back to the shareholders.” BMW is buying back up to 10% of its shares this year.

Harris has large positions in both BMW and Honda. Indeed, it is the second-largest holder of BMW shares after the controlling Quandt family.

@page_break@The development of hybrids by other companies is slightly negative for Honda, however. But it has the advantage of being first out of the gate, along with Toyota, and it will probably be two years before other firms’ hybrids are launched.

> Hyundai. “It’s a very efficient company targeting the lower end of the market. It has much lower wages than its U.S. and Japanese competitors,” says Burbeck.

Hyundai has improved its quality and has had very attractive models in the past few years in all segments, including SUVs. It is very global, selling in both industrialized and developing economies. It is in Brazil, has been very successful in Russia and has become one of the fastest-growing sellers in China in the past five years. It recently set up in the southern U.S., where there are no unions, to build a new model for North America that Burbeck believes is “very attractive.”

> Suzuki. Car ownership is much lower in the developing world, and Suzuki, as both a motorcycle and auto manufacturer, is ideally positioned to take advantage of that, says Burbeck. In poor countries, a motorcycle is the first vehicle most people can afford.
Suzuki’s strategy is to land motorcycle customers, then convert them to cars.

Burbeck describes Suzuki as being where Honda was 40 years ago. And while Honda uses the same strategy in emerging markets, it is not as good an investment opportunity because emerging markets are only part of its business. A much bigger portion of Honda’s business is in the developed world, including North America and Europe, where the market is pretty stagnant and competition is fierce.

Suzuki, which started making automobiles 15 years ago, has been quite successful selling small SUVs in the U.S. and Europe, and minicars in Japan. However, its main focus is on emerging markets, including eastern Europe, Indonesia, Vietnam and India.
It produces in the Czech Republic, but not in France or Germany, where costs are much higher, and it is involved in a joint venture with India’s Maruti Motors.

> Neomax. The key to its success is its patent for a component for hybrid cars. “Sales of hybrids have been phenomenal, especially in the past two years,” says Burbeck.
Toyota, which still has a waiting list for its second-generation Prius hybrid, says it will introduce a hybrid version for every model, including the Lexus, by 2010.

> Continental ag. The tire industry has consolidated in the past few years. There are only five major global players now, including Continental, and returns are much higher than before.

“People are fussy about what tires they put on their cars,” says Burbeck, explaining why competition from Chinese and Indian tire producers is not a problem: people also tend to stay with the same brand of tires that came with the vehicle. “Continental has done well getting tires on the right new models, especially SUV tires, which are very expensive,” he says.

Continental is also the world’s leader in electronic stability systems that are interlinked with anti-lock braking systems. The systems effectively take control of braking, steering and engine power and make it difficult to skid, says Burbeck. Such systems were initially used in high-end cars but are filtering down to less expensive vehicles; in time, all cars will have them. There are no other major producers.

> Borgwarner. This company has an interesting lineup of products that are “highly engineered and positioned right for the sweet spot of what’s going on in the industry,” says Phil Taller, portfolio manager at Toronto-based Bluewater Investment Management and manager of several of Mackenzie Financial Corp. ’s Universal funds.
His focus is on North America, but he considers BorgWarner and Martinrea excellent choices within a global context.

For example, BorgWarner’s transfer cases are all-wheel-drive, a segment that is enjoying growth. The company also sells turbochargers. Virtually all diesel automobiles in Europe have turbos, and this trend will spread to Asia. There is also a move to reformulate both diesel engines and diesel fuel to meet North American emissions standards. Diesel fuel is less expensive than gasoline.

BorgWarner has also developed a “dualtronic” transmission, which gives better fuel economy and generates a better driving experience. BorgWarner’s first contract is with VW, and Taller expects other manufacturers to climb on board.

> Martinrea. It produces items such as fuel tanks, seat frames and parts of the auto frame, and does so very well.

Started by a group that was involved in pushing hydroforming at Magna International Inc. , the company has become a Tier I North American supplier. With very good engineering, it is able to bid for contracts to supply high-quality products at prices that allow for the price reductions manufacturers demand and still have “pretty good margins,” says Taller.

Martinrea is the only pick that doesn’t have a niche or hot product, although it has an idea that could bear fruit. Its vision is to develop a frame that will incorporate management of the auto’s fluids. This would save on weight and cost. It already makes parts of the frame and fluid vessels. IE