Even with recent market strength on the heels of a potential third round of quantitative easing, value plays in the stock market are alive and well. Two names from the consumer goods sector jump out immediately - Ford (F) and General Motors (GM).
Taking a quick glance, the metrics do look intriguing. Ford's trailing P/E ratio is 2.3, and GM's is about 8.2. The PEG ratios are .77 and .64 respectively. Price to sales ratios are also extremely low, at .29 and .24 respectively. GM doesn't pay a dividend, but Ford now offers a solid 2% yield which provides extra incentive to hold the stock for long periods of time. From this perspective, these stocks look like a bargain.
As is always the case, there is a catch. The American auto industry is trying to make a comeback after the severe debt problems it had in the recent financial market meltdown(s), but the market is wavering. Intense competition from foreign manufacturers have also burdened the likes of Ford and GM tremendously, and now that there is so much focus on economic and environmental costs of driving vehicles, we are seeing a paradigm shift in the demand side of the auto industry. This is also accelerated by increasing intervention by the government, particular in the United States.
To simplify the analysis, I will first take a look at GM, including its recent financial data, intentions, and financial position. Then I'll look at Ford the same way in the hopes that we will find meaningful differences between the two that could provide useful insights for investors who may be looking at one company or the other.
General Motors has come under criticism in recent years, not only for accepting government bailouts in the height of the recent financial crisis (which still affects the company due to the government's ~1/4 stake in company equity) but because it's become a more international brand. Early last year it was announced that vehicle sales in China actually surpassed the United States for the first time in over a century of business operations.
GM has made noticeable efforts to appeal to the eco-friendly car demographic with the new highly efficient Chevrolet Cruze ECO which tops out at 42 mpg, and has also been fighting for the electric car market with the Volt. Another article on Seeking Alpha by Freedonia Freelance explained the situation behind the Volt well, and explains why this venture adds significant risk to the company's financials despite its sales growth and apparent domination of the sub-industry.
The really disturbing news for GM stock comes in the form of financial data. The basic metrics that were given above imply that the stock is trading at a steep discount, but there is ample reason.
In Q2 2012, we saw a 28% drop in earnings (EBIT) relative to the same period of time in 2011 caused by weaker numbers from every region and particularly painful losses from Europe. Indeed, Europe has been a real nightmare for GM (and Ford as we'll see later). Since the start of 2012, GM has lost over $600 million from operations there.
Although there are clearly other problems to be found in Europe, GM has had a particularly hard time with Opel. GM has recently tried a change in leadership (taking Karl-Friedrich Stracke off the job and moving vice chairman Steve Girsky in), but I have doubts that this will make any real difference. Opel has been bleeding money for over a decade, and has little hope of recovery without big changes in the macroeconomic environment.
As bleak as the situation looks in Europe, GM still has huge potential in the East - particularly China. As mentioned earlier, GM now sells more vehicles in China than the United States, and its data reflect more growth to come from the emerging nation.
GM International Operations (GMIO) operates the China segment. In the last quarterly report, we only saw a 6% contraction in earnings from GMIO. While this is hardly impressive in an environment where we are seeing double-digit growth in China from other companies, GM does have something to look forward to if the macroeconomic environment improves.
GMIO only brings about 24% of the company's earnings in, but I expect this number to increase significantly and hopefully grow enough to mitigate contraction that may come from other regions (like Europe). GM's statements imply that the company is watching this trend with great interest, and is looking to find ways to eat market share faster than the competition. Its market research seems to imply that certain brands, like Cadillac, will be absolutely key for additional penetration of Asia's auto market - so GM shareholders must have faith that the company knows what it's talking about as development costs grow.
Another big positive for GM is that its balance sheet is solid after the government came and cleaned it all out. As of June 30, GM holds $22 billion in cash and about $70 billion of current assets (assets with enough liquidity to become cash in roughly a year or less). The company's overall net worth is about $42 billion, which is more than the market capitalization of the stock. If GM can convince the market that it can actually grow its sales consistently, expect this discount to vanish quite rapidly.
Ford has seen some great numbers from foreign markets recently. In fact, it just set a new sales record in China due to its ~39% annual growth rate in wholesales. The problem is that its recent figures from the rest of the world aren't looking so great.
In North America, which is supposed to be Ford's top market, we saw a small decline (about 17,000 units) in total sales in the first half of 2012 as opposed to the first half of 2011. Globally, we saw 72,000 less units in 2012 than in the same period of 2011. Pretax income in Q2 2012 dropped about 36% relative to Q2 2011 - quite a bit worse than the numbers posted by GM.
According to Ford's website, the newest model of the Ford Focus with the SFE package (Super Fuel Economy) tops out at roughly 40 MPG at highway speeds. The competitively priced Chevrolet Cruze ECO mentioned earlier beats Ford's flagship car with 42 MPG. Nice little victory for GM there, but hardly enough to tip the balance.
As was the case with GM, Europe is wreaking havoc on Ford's financial data. $404 million was lost in Q2 2012, bringing the total losses in Ford Europe to $553 million. The company blames macroeconomic headwinds, and expects over $1 billion in losses in Europe before the end of the year. It's ugly, to say the least.
Europe is only about 23% of Ford's auto revenue though, and Ford's inability to succeed in Asia to the extent that GM has is not much of a factor due to its huge success in North America. NA income is actually in an uptrend, and seems to be carrying the weight of Europe single-handedly.
Ford's balance sheet, which didn't benefit from any bailout money in the recent financial crisis, has made a substantial recovery and looks poised for additional improvements as the company's margins gradually improve. The $15 billion in cash and $113 in current assets wrap up a company with a net worth of around $17 billion that trades for just under $40 billion.
Who to choose?
Now that we've looked at both companies, it's time to compare them. Both companies have a few major similarities that should be pointed out early though:
- Both companies would benefit from (or be hurt by) macroeconomic headwinds that affect the auto industry
- Both companies are working hard on their fuel economy, which may be hurt (or helped by) the government - particularly within the US. This means that the upcoming presidential election may have big impact on perception of GM and F stock
- GM and Ford both have nightmare scenarios in Europe, so expect any worsening of the EU situation to hurt these stocks dramatically
There are many differences too, of course, but these four may be the most important:
- GM is trading at a steep discount relative to its net worth while Ford is trading above book value
- Ford pays a dividend while GM does not, and GM is still largely owned by the US government
- GM's fate is heavily tied to China, Ford's fate stays with the US economy
- Ford, in general, is able to make more money and has proved this by fixing its balance sheet since the recent financial crisis
Overall, while I like GM's prospects in China a lot, Ford looks like the better long term investment here. GM does trade at a steep discount, which may convince some value investors of its potential as a stock, but Ford's ability to perform so well in North America is worth so much more. Ford really is the better buy, at least for now.
Having said that, the auto industry as a whole is a very scary place to be. Labor data remains weak, and as mentioned earlier we are seeing nothing short of chaos out of Europe that may suppress F and GM earnings for quite some time. Be careful, and best of luck out there.
A note: If you want to buy, I'd seriously consider Ford anywhere under $9 or 10/share (assuming no catastrophic events) and GM under $20/share or so. These are very rough estimates, and more research should be done if you are seriously considering these company stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.