3 Auto Stocks With A Strong Upside And 2 That Could Go Lower

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 |  Includes: AZO, GM, JCI, ORLY, TM
by: Efficient Alpha

Sales of motor vehicles in the United States are released at 2 p.m. Eastern with expectations for an increase to 14.2 million on a seasonally adjusted annualized rate. Total sales slowed last month to 14.1 million from 14.4 million in June, mostly on a slowdown in domestic light vehicles.

Though sales dropped last month, they still registered the sixth month this year above 14.0 million and an increase of 9% over the same month last year. Even with the rebound this year, sales are still well below the 10-year average of 17 million annually through the year 2007. The National Automobile Dealers Association forecasts sales to increase 11.8% to 16 million by 2014.

An increase in gasoline prices over the last month may weigh on the report, especially on sales of light trucks. Consumer confidence also slid in August to the lowest level in nine months though spending remained resilient. While weakening consumer confidence may lead to a moderation in sales over the next couple of months, pent up demand should increase as the age of vehicles on the road increases and leads to stable growth in the next few quarters.

Strong Trend Upwards with Headline Risk to be Hedged

Shares of auto makers have been mixed over the last year while auto parts companies have done relatively better. Strong fundamentals for demand should act as a tailwind for the industry over the next several quarters though investors may want to hedge against the risk of a negative surprise in sales today and before each month's report.

General Motors (NYSE:GM) reported a year-over-year sales decline of 6% though year-to-date sales were up on last month's domestic sales report. Shares fell 2.9% last month on the weak vehicle sales report and are down 3.3% over the past 12 months. The company has an operating margin of 3.4% which is roughly in-line with peers. The company's inventory turnover of 8.9% is slightly above the industry average of 6%. The stock trades at 7.6 times trailing earnings but pays no dividend.

GM said recently that it expects Volt sales to reach a monthly record of 2,500 in August though it will be shutting down production temporarily for retooling and other work to prepare for 2014 production. A weaker dollar and stagnant real wage growth should help domestic producers going forward. Shares of GM look attractive on a valuation basis relative to peers.

Toyota Motor (NYSE:TM), along with other Japanese producers, reported a strong 26% year-over-year rise in sales last month against easy comparables due to last year's natural disaster and supply shortages. Shares managed to gain 0.7% last month in spite of the weak vehicle sales report and are up 14.8% over the past 12 months. The company has an operating margin of 4.0%, and its inventory turnover of 11.9% is well above the industry average. Still, the stock trades for a relatively expensive 17.2 times trailing earnings and pays a 1.6% dividend yield.

Last week, the company accused a former programmer of sabotaging applications and stealing proprietary data. No report of possible damages has yet been made but the company reported that any leak would be, "highly damaging to Toyota, and its suppliers, causing immediate and irreparable damage." Shares look relatively expensive on a valuation basis and may underperform on headline risk as the story develops.

O'Reilly Automotive (NASDAQ:ORLY) warned in June of slowing sales growth and guided to the lower end of profit expectations for the quarter. Despite a trend to older cars on the roads, the increase in new car sales may be starting to weigh on retail auto parts. The company has a strong operating margin of 15.6%, well above peers in the sector. Despite strength in cost controls the company's inventory turnover is lower than peers at just 1.5%. Shares fell 1.4% last month on the weak vehicle sales report but are up 29.2% over the past 12 months. The stock trades for a relatively expensive 19.6 times trailing earnings and pays no dividend. The shares are expensive relative to peers and investors may want to use a short to hedge against a long position in competitors with stronger fundamentals.

Shares of AutoZone (NYSE:AZO) fell 4.7% on the warning by O'Reilly as investors rushed to the exits in parts suppliers. The company has the highest operating margin of the group at 18.8%, meaning management effectively controls costs and expenses, but inventory turnover is lower than peers at just 1.6%. Shares fell 3.4% last month on the weak vehicle sales report but are up 16.3% over the past 12 months. The stock trades for 16.2 times trailing earnings and pays no dividend. The shares are relatively cheaper and the company is attractive from a fundamental basis relative to peers.

Fitch revised the credit rating of Johnson Controls (NYSE:JCI) to negative last week on concerns for negative free cash flow and higher debt. Free cash flow could be positive in the next quarter on lower capital expenditures. The company has an operating margin of 5.2% which is in-line with peers in its sector. Inventory turnover at Johnson Controls is 15.0%, well above the 5.4% sector average. Shares fell 3.3% last month on the weak vehicle sales report and are down 8.9% over the past 12 months. The stock trades for a relatively cheap 10.8 times trailing earnings and pays a 2.7% dividend yield. Despite the negative credit news, the company remains attractive on a valuation and fundamentals basis.

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.