These 4 Auto Stocks Are Unlikely To Fuel Your Portfolio

Includes: F, GM, HMC, TM
by: Dividend Kings

Don't let the attractive price multiples of Japanese and U.S. automaker stocks fool you. Yes, they are often trading at low valuation multiples. However, these discounts come at the cost of higher risk. Ford (NYSE:F) is highly leveraged and General Motors (NYSE:GM) seems eager to build up its leverage. On the other side of the Pacific, Japanese automakers are domiciled in a country with an expensive and appreciating currency, which makes their low price-to-book ratios less attractive to American investors. In addition, these companies are experiencing a backlash from angry Chinese customers and counterparties.

The Bait: Low Valuations

Current financial metrics illustrate how these stocks appear attractive on the basis of price multiples:
















General Motors




















Ford has the amount of debt one would expect from a financial services company. Arguably it is more of an auto-loan company than a carmaker.

General Motors is also trying to lever up by gaining access to an $11 billion revolving line of credit. This borrowing facility consists of $5.5 billion, which will mature in five years, and $5.5 billion, which will mature in three years. The adoption of this credit line doubles its $5.5 billion five year facility that was on schedule to mature in 2015. General Motors' website states how this credit facility "offers improved pricing and terms, and the ability to borrow in currencies other than U.S. Dollars." Over 35 institutions from 14 countries participated in this enormous deal.

This expanded line of credit gives General Motors more borrowing power than Ford, which has access to $9.3 billion in credit facilities. Dan Ammann, General Motor's Chief Financial Officer said, "The new revolver provides a significant source of backup liquidity and financial flexibility, further bolstering our fortress balance sheet." He added that the new line of credit "represents a strong vote of confidence in the financial strength of our company."

Falling Ford Profit Margins

Ford has announced that profit margins are falling in North America due to a shift in demand to smaller cars. Fewer oversized trucks have been sold as consumers have substituted smaller cars. This shift in demand is expected to reduce profit margins to a value between 8% and 10% over time, lower than the 12% profit margin reported for its third quarter. However, profit margins have not completely declined, and sales from new models, such as the 2013 Escape SUV have risen, with a price tag that commands $4,200 more per vehicle than older models.

General Motor's earnings before taxes in North America were $6.47 billion in the first nine months of 2012, which amounts to more than the company's total profit in 2011. The North American region has an operating profit margin of about 11.2% in an industry where a profit margin of 5% is considered as good. But fourth quarter results may not materialize as expected.

The promotion of Mark Fields to the position of COO has led to the transformation of the North American operations into a profitable unit, earning record profits compared to its huge losses four years ago. 5,200 hourly jobs and 900 salaried positions have been generated based on this strong performance.

In the U.S., car and light truck sales have seen increases of 0.3% last month. But this gain is far lesser than the 6.9% gain seen across the industry. Hurricane Sandy could be blamed for lower than average sales. The share in the U.S. market has fallen from 16.8% last year to about 15.5% this year. This is contrary to Ford's 2009 to 2011 U.S. market share growth.

Ford is not doing well overseas. Its South American operations are generating an operating margin of only one percent. Governmental incentives to boost production capacity have yet to raise sales. The company has already boosted supply in the region, leading to price weakness and precarious margins. However, the product line will undergo some changes with the introduction of higher margin models. The Ford Sedan will be introduced in South America in the first quarter of 2013.

European sales have declined, and Ford announced that the company would lose around $1.5 billion this year due to the European sovereign debt crisis. Car sales have hit their lowest level of sales in about 19 years. The company is planning to cut 6,200 jobs and close three European factories by 2014.

Government Motors

Are U.S. automakers really profit-maximizing businesses, or do they exist to provide economic stability? The question is whether these are investible businesses, or whether they are political devices?

Political mechanisms create jobs. General Motors decided to take around 3,000 IT Hewlett-Packard (NYSE:HPQ) experts to increase its in-house information technology resources. General Motors will house up to 10,000 IT experts from HP in two new innovation centers located in Austin, Texas and Warren, Michigan. General Motors currently meets more than 90 percent of its IT needs through outsourcing. This move would decrease its dependency on outsourcing.

Chief Information Officer Randy Mott said, "General Motors is undergoing one of the most profound transformations in our corporate history and GM IT is an important part of that transformation. We're transforming our IT operating model to improve performance, reduce the cost of ongoing IT operations, and increase the level of innovation that we deliver to the business."

Japan's Automakers are Lemon Stocks

Japanese automaker stocks are not any better investment prospects. Yes, Honda (NYSE:HMC) and Toyota (NYSE:TM) have attractive price-to-book ratios. However, these price multiples use book values denominated in Japanese Yen, which trade well above purchasing power parity. Worse yet, Yen appreciation can reduce the competitiveness of Japanese exports.

Chinese Anti-Japanese Sentiment

Anti-Japanese protests in the People's Republic of China have erupted based on a territorial dispute with Japan. This unrest is hurting sales in China for Japanese products.

Both Japan and the People's Republic of China insist they control islands named Diaoyu in Chinese and Senkaku in Japanese. Problems erupted when these islands were purchased by a Japanese private buyer. The significance of these islands is in their fossil fuel resources. When this purchase hit the news, Chinese citizens responded with strikes, boycotts, and riots against Japanese trade partners.

This dispute is especially bad for automakers, since Japanese cars symbolize Japanese economic domination. Protests forced Toyota and Honda to shut down manufacturing plants in China.

The damages are already materializing globally. Mitsubishi reported a 63% drop in sales. Mazda reported a 35% fall in monthly car deliveries. Amazingly, shipment figures dropped below those seen in the aftermath of the Japan Tsunami disaster.


Ford and General Motors should be considered risky based on leverage even though they trade at low valuations. Japanese automakers Honda and Toyota face considerable headwinds in China and have Yen exposure. They are not better alternatives for American investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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