Ford, GM: Best Value Plays In A Can't-Lose Sector

 |  Includes: F, GM, HMC, TM
by: Ry Frank

All signs point to a great year for the auto industry. The economy is improving, interest rates remain low and the last few years for carmakers have been terrible. The pent-up demand for automobiles has to be at record levels. Coming out of the Great Recession, it only makes sense consumers are considering the car purchase they have been putting off.

Furthermore, the automobile industry is an inherently cyclical industry. This cyclicality is based on economic factors as well as business factors. Auto companies tend to get out of touch with customers when times are good. Hard times such as this force car companies to refocus on meeting customer demands. This can be seen across all auto companies this year, as most are coming out with totally revamped lines.

So now for the hard part: Which auto company should you pick? The easy choice is to buy them all and eliminate company specific risk, however, we want to pick a winner. I'll focus on Ford because of the attention Ford (F) has been receiving lately, but I'll also take a look at the other major players.

To get right to it, Ford is trading for 8.1 times forward earnings and a deceptive 2.5 times trailing earnings. I say "deceptive" because over half of Ford's income from last year came from deferred tax assets, totaling to a huge $4.94 earnings per share for a stock trading in the $12 range. Still if Ford just has a repeat of last year, less the tax assets, earnings per share should come in well over $2, which would spell a huge jump in share price even at current valuations. However, current analyst estimates for 2012 are in the $1.50 earnings per share range.

Why are analysts so pessimistic?

Last year wasn't a great year for carmakers but the aftermath of Japan's devastating earthquake left Honda (HMC) and Toyota (TM) hobbled. Ford picked up some of the slack and gained market share, however this market share increase is, without a doubt, temporary. Going forward Ford will face steep competition from every direction as the Japanese carmakers recover.

The good news is the data for auto sales through March of this year has been very strong. The numbers look to be the strongest sales figures since February 2008. The individual company breakdowns are all the more telling. Sales for General Motors (GM) expanded a slight 1.1%. Toyota and Honda sales both grew 12% while Ford sales grew 14%. The standout performer however was Chrysler, which increased sales 40%. These numbers are much higher than Kelley Blue originally predicted.

Looking more closely at the competitors it becomes clear what is making Ford look like an attractive investment. The multiples for Toyota and Honda, at 41.9 and 24.4 times forward earnings, are just simply too high for value investors to get interested. The valuations for Ford and General Motors, at 8.1 and 6.5 times forward earnings respectively, are another story. When a stock trades at multiples like this, going into an impending economic recovery and great industry outlook, value investors better get interested.

The trouble is both of these stocks have been sagging lately while the broader market is rapidly expanding. I'd like to think the market is being kind and waiting for all the value investors to hop aboard before these car stocks take off but that's unlikely. The real measure for these stocks will be the next round of earnings. All the sales and economic signs point to strong earnings through the first quarter. However, until its official it looks like these auto stocks will lag.

As far as the best pick of General Motors and Ford, it is a tough call. Ford has done an outstanding job cutting costs and revamping its car line. The company's current annual report does a great job explaining the initiatives the company has put forth to get the company back on track. The company's efforts to cut costs and improve profitability seem to have paid off so far.

While Ford's net profit margin over the last twelve months is overstated at 14.8% due to the income tax assets, if those are subtracted out the net profit margin is still solid at 6.4%. This is a great improvement over the 1.7% profit margin the company averaged over the last 5 years. Additionally, the early sales figures show Ford's new cars are appealing to customers.

General Motors seems a little stodgier and is yet to improve profitability the way Ford has. The company's profit margin is a paltry 4.1%. Going forward however, I believe General Motors scale will pay off big time in an improving auto market. Couple that with General Motors' dirt-cheap earnings -- 6.5 times forward earnings -- and this is a great value play. Furthermore many of the problems that have traditionally plagued General Motors have been removed through the bankruptcy process.

While the auto industry looks to be a can't-lose sector, the best value plays are in the beaten down behemoths and that would be Ford and General Motors. Look for these companies' share prices to rise significantly as earnings come out and the economic environment continues to improve.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.