It was a banner day for the stock market on Friday, June 29, as the Dow Industrial Average jumped 278 points, or 2.2%. The Standard and Poors 500 index rose 2.5%, and the NASDAQ composite index rose 3.0%. The reason for this broad and steep rise was that overnight on the night of June 28, a late night session of European leaders reached a long overdue decision to bail out European banks without encumbering struggling nations like Spain and Italy with increasing sovereign debt. Vague promises were also made that the EU would do more to act cohesively. The domestic stock market acted positively, obviously, as a more stable European economy would do much to lift not just the European economy, but all companies with European exposure as well.
Well, as the stock market surged, General Motors Company (GM) stock dropped 10 cents, or 0.5%. Ford Motor Company (F) stock dropped $0.50 cents, or nearly 5%. Both these companies have substantial exposure in Europe, and have taken a beating as the economy there lost stability. So, why would these two global automotive giants not share in the good news?
Ford for one announced on June 29 that its international division, the bulk of which is in Europe, would suffer a loss of up to $570 million in the second quarter of the year, or triple the $190 million loss from the first quarter of the year. Just a few months ago, Ford said that it expected full year European losses of $500- $600 million. The rationale is simple enough. Just because European leaders have finally committed to work to save the European Union, does not mean the economies of Ireland, Greece, Italy, and Spain will magically improve.
Ford shareholders have had a rough last 12 months, as since July 1, 2011, the stock is down 32%. But over this same period, the company has earned some $5.5 billion, or $1.43 per share. That does not even take into account the massive one time gain of $12.4 billion in the first quarter stemming from a tax loss carry forward. The stock is selling at an absurd price to earnings ratio of 6.6, again omitting the accounting gain.
Ford's domestic business is humming along on the strength of its award winning automotive and light truck line ups. Ford's current market share of just over 15% is expected to rise by about 100 basis points during the second half of 2012, according to a report from UBS Investment Research. But Europe, and most of the company's other operations, are performing so poorly surely some at Ford Headquarters are seeing it may be time for the company to punt on much of its non-North American business; the exception being China.
The burgeoning middle class of China is anticipated to support as much as 32 million car sales per year, roughly double what is sold in the United States. Ford is not a big player there as yet, but does it not make sense to transfer capital from Europe, whose economic decline may take years to turn around, and place that capital into a market all but assured to grow over the intermediate to long run at a rate far outpacing Europe, and North America for that matter? Ford is already committed to spending over $4 billion to increase its production and distribution presence in China, India, and elsewhere in Southeast Asia.
Ford is not going to have a good year this year, during which due to the disclosed European pressures, Ford will be lucky to even approach 2011 earnings. But beyond this year, by betting more on Asia, and less on Europe, Ford has the product, cost structure, and management expertise to thrive. The stock is trading just above its 52 week low, and I don't believe there is a better long-term play in the Dow Industrial Average.
General Motors has not been as forthcoming as Ford about the European economy. It has not announced any special earnings concerns, and that is why its stock price did not bomb as badly as Ford's did on June 29. Otherwise, GM's earnings and financial picture is more opaque than Ford's perhaps in part that the United States Treasury, Canadian government, and major labor unions still own a large chunk of the company, with the largest share being the 26% owned by the Treasury. I don't know when, if ever, General Motors stock will trade at above $51, the breakeven point for American taxpayers.
Like Ford, GM has undertaken a novel way to deal with, in its case, a $25 billion pension underfunding. It is offering nonunion employees buyouts in lieu of pension rights, and expects, conveniently, to whittle down its pension obligation by $26 billion under the program. Any retiree that refuses the one-time buyout or is otherwise ineligible (typically a function of the retirement date of the employee) will receive a group pension administrated by Prudential Financial, Inc. (PRU), as GM is determined to get these liabilities off its books. With Ford, on the other hand, if a retiree does not opt in for the buyout, that employee will retain the traditional Ford defined benefit plan.
GM is facing two distinct issues right now. Like Ford, Europe is money loser for the company. GM lost $256 million before interest, depreciation and taxes in the first quarter. Without any specific guidance from the company, the second quarter will almost surely be worse. The second issue right now is that GM has a domestic market share of 17.5%, a level so low that it was last at this level in the 1920s. To the company's credit, it is remaining solidly profitable in North America despite the lower sales volumes, but this is a trend that GM must turn around by designing the kinds of vehicles that customers want.
Partly because I don't want to share a company with Uncle Sam, and partly because I view General Motors prospects as more fuzzy, not necessarily worse than Ford, I prefer Ford as a long-term investment. But GM, selling at a five-year PEG of just 0.41, surely has some appeal as well.