While everyone else is scared of a depression, we are genuinely excited about the next phase of the American auto acceleration. Barely noticed by most investors, this resurgence is real and gaining strength. Balance sheets are healthier, earnings are stable and growing, and a wily confidence exists amongst the executives of our leading auto titans.
Stabilize, Walk, Then Run
Understanding where we are in an economic cycle is very important to deciding the value of an investment or investment sector. Both the direction and speed must be gauged to determine if we are going forward or in reverse, and if the engine is revving too hot or purring, like it should. The US auto industry has certainly stabilized, and in fact seeds of growth are now starting to bear shoots of green.
Brakes Put On
When General Motors (GM) and Chrysler were bankrupted and bailed out in '08/'09, the US auto industry hit bottom. Industry sales in the US and worldwide hit cyclical lows (2009 US sales of 10.4 million units). As distasteful as the government intervention was to ordinary citizens, it did manage to bring forward the pain across all sectors of the industry. An industry in decline was forced to accept massive write-downs of past mistakes; allowing them to streamline their production sprawl, union contracts, supplier relationships, and debt-based capital structure.
By hitting the brakes in '08/'09, the stage was set to grow again, albeit at a slow and steady pace. In 2010, production grew from the anemic 2009 levels of 10.4 million, to a still low, but healthier 11.6 million in 2010. This year promises even further modest growth with estimates ranging from 12.5 to 13 million vehicles. However, it should be noted that 2008 sales were 13.4 million, and 2000 to 2007 sales averaged 16.8 million.
First Gear and Moving Forward
As the companies have bounced off of trough levels of sales, they have demonstrated their new earnings model by rolling out solid profits and cash generation. For example, Ford (F) and GM generated $21.5B in combined earnings in the last year and a half (F $11.5B, GM $10B). Ford has improved their total automotive gross cash less automotive debt by $17B since Dec '09, and General Motors' total automotive cash now exceeds $33B (only $7B shy of their entire market cap). Suppliers have also participated in this recovery at a steady pace, with earnings and cash levels rebounding nicely for leaders Magna (MGA), Lear (LEA), and Dana (DAN).
What makes the US sector exciting is that the industry is still well below its average of 16.8 million auto sales, while the average age of a US car is now at the oldest ever at 11 years and counting. Couple the low trading multiples due to the pessimistic macro-view of the economy, and it is very easy to see the opportunity going forward.
Pedal to the Metal
Whether 2012, 2013, or soon thereafter, at some point the US auto production will revert towards the mean of 16-17 million vehicles sold. When this happens, profitability will not only grow, but explode to the upside. All participants in the industry are very leveraged to incremental sales gains, as the production of autos requires heavy capital investment with years of lead time in planning. As incremental profitability becomes visible to the analysts, the market will recognize the value and assign value based on a forward look to the future.
While America's Big 3 operate across the world, the major engine of growth and profits has always been from their US sales. Consequently, the lack of recognition of the value of their international operations has been systemic throughout the years, even though both GM and Ford having sizable market share in the worldwide oligopoly. As countries such as China, Brazil, and India continue to grow, the race to lead in these markets will have incremental value. GM is leading with about 12% total share, but F is close behind with about 10%.
5 Stocks for US Auto Rebound
We believe that a worldwide rebound is coming in 2012 and autos will lead the way. In particular, we like the top two automakers (F and GM) and three top suppliers (MGA, LEA, DAN).
Ford is a favorite for several reasons: 1) low PE 2) best management in industry 3) managed through the storm without direct bailout 4) strong and growing international presence 5) ahead of competition in implementing worldwide production platforms. Ford has recently raised their net cash position to $8B by reducing outstanding debt and saving billions in future interest payments.
GM is a co-favorite with F for slightly different reasons: 1) low valuation, due to debt reduction through bankruptcy 2) number 1 producer worldwide, including number 1 position in China 3) cash position strong at $33.8B and growing. GM is behind F in implementing structural production reforms, but is moving in the proper direction. By 2018, it expects to cut its worldwide platforms to 14 from 30, and this should further improve GM's efficiency and time to market.
Magna, Lear, and Dana are also favorites as they too will benefit from a resurgence in US auto production. As top tier suppliers with solid relationships to the main producers, their workload will increase with the growth of overall production figures, and their profit potential can be maximized. All three trade at single digit price earnings multiples, which gives plenty of room for multiple expansion in addition to the actual earnings growth.
eps $1.91 '10, $1.97 '11, $1.99 '12 Market Cap $42B 2011 PE 5.6x
General Motors ($25.75)
eps $3.11 '10, $4.27 '11, $4.77 '12 Market Cap $40.2B 2011 PE 6x
eps $4.33 '10, $4.8 '11, $5.24 '12 Market Cap $9.4B 2011 PE 7.3x
eps $4.42 '10, $5.46 '11, $6.04 '12 Market Cap $4.8B 2011 PE 8.4x
eps $0.61 '10, $1.67 '11, $2.01 '12 Market Cap $2B 2011 PE 8.2x
The fundamentals combined with the knowledge that the acceleration phase of this recovery is just beginning, give the investor a unique opportunity. American auto sales will grow and the companies involved will benefit. We believe that while the market is worried about a recession/depression, astute investors should use the opportunity to buy. Risk/reward is an important concept in investing, and those that pay attention to this trend won't regret it.