Buyer beware! Japanese and U.S. automaker stocks may appear attractive based on low valuation multiples, but these discounts come at the cost of higher risk. Ford (F) is leveraged, and General Motors (GM) is following suit. Japanese carmakers are experiencing a backlash from angry Chinese customers and counterparties. In addition, the Yen is an expensive and appreciating currency, which makes their low price-to-book ratios less attractive to American investors.
The Bait: Cheap Valuations
Financial metrics show how these stocks appear attractive on the basis of price multiples:
Ford and GM are Closet Financial Companies
Ford's high leverage is characteristic of a financial services company, not a manufacturing company. This, it is useful to think of it as an auto-loan company that also makes cars.
General Motors is following Ford's lead by levering its balance sheet and acquiring more financial operations.
General Motors' subsidiary GM Financial is buying Ally Financial's European and Latin American operations for $4.2 billion. For Ally Financial, this follows a similar sale of its Canadian and Mexican operations in May in efforts to raise funds for faster repayment of US bailout funds. Also in May, Ally Financial's mortgage unit Residential Capital filed for bankruptcy and recently the court judge approved the sale of its operations to Walter Investment Management and Ocwen Financial for $3 billion. Another $1.5 billion of the loan portfolio is offered for sale to Berkshire Hathaway.
For GM, this is a strategy of strengthening its in-house financing operations in hopes to increase auto sales. Note that Ally Financial was the former General Motors Acceptance (GMAC) - GM's former financing arm. With this (re-)acquisition, GM hopes to duplicate its sales increase in North America in 2010, after creating GM Financial to handle in-house financing. GM's CFO, Dan Ammann said, "GM has realized about 200,000 additional auto sales in North America since it created GM Financial." With this deal, GM Financial hopes to increase earnings before taxes by $300 million to $400 million annually.
Although the US government still holds shares in GM, the transaction doesn't need its approval anymore after the GM's Board of Directors has given its go-signal, Ammann said.
GM explained that the purchase involves Ally Financial's operations in Brazil, Chile, Austria, Colombia, Belgium, Italy, the Netherlands, France, Britain, Germany, Sweden and Switzerland. Ally's 40% interest in GMAC-SAIC Automotive Finance Company - its joint venture in China is also included. GM is expected to contribute $2 billion to finance the purchase.
General Motors also levering up by gaining access to a revolving line of credit with a $11 billion maximum balance. The adoption of this credit line doubles its $5.5 billion five year facility which was scheduled to mature in 2015. General Motors' website states how this move "offers improved pricing and terms, and the ability to borrow in currencies other than U.S. dollars." This huge line of credit involved an army of different bankers. Thirty-five institutions from fourteen different nations participated in the deal.
Ford has access to $9.3 billion in credit facilities, so this expanded line of credit gives the General Motors more borrowing power than Ford. CFO of General Motors Dan Ammann said, "The new revolver provides a significant source of backup liquidity and financial flexibility, further bolstering our fortress balance sheet." He also mentioned that the borrowing facility "represents a strong vote of confidence in the financial strength of our company."
Investors should be worried because General Motors went bankrupt in the financial crisis and is now borrowing and acquiring more financial operations. None of these attributes is a good indicator of future financial stability.
Japan's Automakers are Lemon Stocks
Japanese automakers are not any better as stock investments. Sure, Toyota (TM) and Honda have attractive price-to-book ratios. However, these price multiples are based on asset value denominated in Yen, which trades above purchasing power parity. Even worse, currency appreciation could reduce the competitiveness of auto exports for these companies.
Chinese Anti-Japanese Sentiment
Anti-Japanese protests in the People's Republic of China have erupted based on a territorial dispute with over two fossil fuel-rich islands. Problems erupted when these islands, named Diaoyu in Chinese and Senkaku in Japanese, were purchased by a Japanese buyer. Chinese citizens responded with boycotts, strikes, and riots against Japanese domiciled trade partners. This unrest has hurt sales in China for Japanese products.
Nissan, a Japanese carmaker with significant sales in China, reported a 20% cut in its net income forecast as a result of consumer backlash that arose due to territorial dispute in China, the largest market for its sales. The company forecasted that for the year ending March 31, its net income may decline to $3.87 billion as compared to $4.84 billion as estimated earlier and its operating income may decline to $6.96 billion from its earlier forecast of $8.47 billion. The company declared a cutback after the Honda (HMC) which declared a reduction in its profit forecast, depicting a handicapped image of these companies.
In the previous quarter of July to September, the company reported results above the analyst expectations. Nissan had a $1.28 billion net income against the estimate of $1.11 billion and operating income was $2.01 billion as against the estimate of $1.99 billion projection.
Production volume is starting to heal after protests in China. The company expects things to normalize year end.
Ford and General Motors should be considered risky based on leverage even though they trade at low valuations. Japanese automakers Honda and Toyota are enduring fierce politically-motivated headwinds in China and have Yen exposure. They are not better alternatives for American investors.