Wall Street Strategies'  Instablog

Last week, at the Frankfurt auto show, we saw what the future of the auto industry will look like, and this week we are reminded what the current industry looks like.   

Looking at all the futuristic vehicles and cars that will get almost 250 miles per gallon, it is difficult not to get excited about the future. Imagine never having to fill up your car at a gas station again or just plugging your car into a normal socket in your garage.  While a few years ago we could only these innovations in the Jetson’s, technology and climate demands have now made these cars a reality.  The Chevy Volt comes out next year, Nissan’s Leaf is on its way to the market, and other fully electric vehicles from Ford, Toyota, and Volkswagen are all in the final stages of development.   

This week, however, brings us back to the cruel environment that is the current automotive industry.  Auto sales are expected to be dismal this month, following last month’s strong showing resulting from the cash for clunkers program.  These types of programs have been successful in the United Kingdom, Germany, and the United States, and now Canada is jumping on the Cash for Clunkers program with its Recycle Your Ride program.  The incentives didn’t end in the United States after the program ended (think Hyundai’s added cash incentive), but dealerships don’t have the same incentive to sell a car as inventories across the nation are at extremely low levels. We have all seen new GM Chairman Ed Whitaker in his new GM commercial offering a 60 day money back guarantee. It will be interesting to see the response to this program.  It is a very risky proposal for GM; any customers that trade in their vehicle in the 60 day period will never again be GM buyers. 

Elsewhere in the auto world, Ford (F) is trying to stake its claim in the emerging markets, most notably in India, While General Motors has a solid beachhead in China. In India, CEO of Ford Alan Mulally unveiled a new low-cost small car specifically developed for Asia that will be built at a newly expanded Indian plant. The vehicle, which is called the Figo, will be sold in India and exported to other countries in the Asia-Pacific region.  Ford will also open its third plant in China later this week.

China is likely to pass the United States as the largest auto market in the world during 2009, and currently Ford can produce 447,000 vehicles (and with the third plant, production is expected to increase to 600,000).  Ford is already significantly behind its larger rivals, Toyota (TM) and GM, which have an annual production of 800,000 vehicles and 1.29 million vehicles per year, respectively.  The majority of foreign production in China is done through joint ventures with Chinese companies.  Countries like China, India, Brazil, and Russia, as well as regions in the Middle East are the future growth regions for the auto market as a whole.  Western Europe and North America are basically mature markets, and the growth over the next few years is likely to improve in the mid to high single digit ranges, while overseas, markets are growing at breakneck paces, some greater than 40%.

GM has the upper hand with respect to the Chinese market, but it will be a long time before the U.S. government has its hands out of the automaker’s pockets, which will give other companies an advantage. That being said, we are bullish on most companies in the auto industry as they emerge from the Great Recession.  Our favorite is Ford. We feel that the Dearborn, Michigan company has a solid turnaround plan, and Mr. Mulally is implementing it well.  There are a few out there that think its high debt level (compared to GM and Chrysler which were able to shed those astronomically high debt levels during bankruptcy) will hinder future growth, and the fact is it has the chance to slow growth, but we think that the worst has past for the industry, and that debt levels, while high, will not restrict growth significantly. There will probably be another debt to equity conversion, but that should be viewed positively (despite the dilution effect) as there will be less weight on the Company’s shoulders.  Cash burn has been decreasing steadily over the past two quarters and we expect to see a strong figure (but still a burn) during the third quarter.  The second quarter of 2010 is when we have modeled for Ford to turn cash flow positive.  Refer to our website, www.wstreet.com for an example of our institutional research.

Written by David Silver, a Research Analyst for Wall Street Strategies (wstreet.com) covering companies in the Transports, Autos, and Beverage sectors.  For more information about Mr. Silver, refer to the company’s website,wstreet.com.