With Valuations Rising, Consider Automakers Carefully

Includes: F, GM, HMC, TM
by: Bill Maurer

We all know that the recession took a toll on many industries, and US automakers were one of the hardest hit. Ford (NYSE:F), General Motors (NYSE:GM), and the like were punished, but they have recovered a bit. US auto sales in 2011 were at their highest level since 2008, although the 12.8 million number was still well below the 16 million level we saw before the recession.

For the automakers, unit sales are up, as are prices. The average price of vehicles sold in December was up 5% over the year ago period. You might think that's good for these stocks, but that is only half of the picture. They aren't quite getting these increased revenues to the bottom line. These names have risen in price over the past 3 months, and analysts have been cutting earnings per share numbers left and right. That has pushed valuations higher, and that may lead some investors to stay away from these names.

Let's look at Ford first. When Ford reported third quarter and nine month results for the year, revenues were up quite nicely. However, net income was down, and thus, earnings per share were too. Third quarter revenues increased from $29.89 billion to $33.05 billion, but net income declined from $1.687 billion to $1.649 billion. Thus, earnings per share declined from 49 cents to 43 cents.

Ford's sales were up 11% in 2011 on a unit sold basis, and revenues are currently expected to be up 15% on the year. However, earnings per share are currently expected to decline from $1.91 to $1.87. Three months ago, they were predicted to rise by 2 cents.

Why is this such an issue? Well, next year, Ford is only expected to increase revenues by 3.5%. Earnings per share are expected to fall, and more so than they were just three months ago. Take a look at the following earnings estimate chart from Yahoo:

EPS 2011 2012
90 days ago $1.93 $1.77
60 days ago $1.89 $1.66
30 days ago $1.87 $1.62
7 days ago $1.87 $1.59
Current $1.87 $1.58

Analysts have taken down expectations by 19 cents in the past three months, and if you go to CNBC, the number they show for consensus in 2012 is just $1.54. Now, in the past three months, Ford's stock is actually up about a dollar, despite the lowered expectations. This has led to the P/E valuation increasing quite a bit.

P/E 2011 2012
90 days ago 5.54 6.04
60 days ago 5.84 6.65
30 days ago 5.90 6.81
7 days ago 5.75 6.77
Current 6.26 7.41

On Friday, Ford traded at its highest level since late October, but even since then, we've seen estimates come down by nearly a dime. Now the average analyst price target for Ford is $16 currently, and just using current estimates, that would be a P/E of about 10, more than a third above where we are now. I want to use this as caution, because I think we could see estimates come down even further going forward. We could see the price rise even if earnings come down, but at some point, the company will need to grow profits.

Looking back to the past couple of years, Ford has traded in the 4 to 11ish range in terms of P/E's, so it is fair to say that we are basically in the middle of the range. However, we've come up a bit in the past few months, and if the trend continues, we might find ourselves at the high end of the range before long.

If you think this is a company-specific issue, it's not. Here are two more examples, the first being GM, and the second being Honda Motor Company (NYSE:HMC).

GM P/E 2011 2012
90 days ago 5.17 5.05
60 days ago 5.21 5.19
30 days ago 5.35 5.42
7 days ago 5.16 5.31
Current 5.83 6.05

General Motors is expected to increase revenues at an 11% clip this year, and like Ford, a smaller number at 4% in 2012. GM's earning expectations have come down more than Ford's, on a percentage basis, over the past 90 days. However, GM's stock is only up 4.13% during that time, while Ford's is up 9.54%. That's why the P/E growth numbers are as close as they are. Honda's stock is up 10.15%, but since its expectations have not come down as much, the P/E number has not increased as much.

HMC P/E 2011* 2012*
90 days ago 13.96 7.22
60 days ago 15.55 7.97
30 days ago 18.55 8.15
7 days ago 18.29 8.08
Current 19.24 8.50
2011 fiscal year ends in March 2012; 2012 FY in March 2013.

I'm sure you will ask about Toyota (NYSE:TM), but due to the earthquake and recent flooding in Asia, its earnings estimates have been too volatile to make a true comparison.

The article I referenced above does make another important point I should discuss. US automakers did well, while their Asian counterparts did not, due to lingering issues from the 2011 earthquake and tsunami, as well as the recent flooding. As Toyota, Nissan, and the like get back on their feet, it might come at the expense of the US automakers.

Overall, you can still buy these names, but just know that you are paying approximately 20% more on a 2012 P/E basis than you were 3 months ago. Ford has reinstated its dividend, so that is a positive sign for the company. Ford has beaten expectations the past three quarters, but maybe that will stop the decrease in estimate revisions for a while if it beats again.

Valuations are always a tricky subject, so my point here is not to say that you have to use the P/E number for every argument. You don't. All I'm saying here is that the numbers have risen by a decent number in the past months, and that is causing me a little concern. I still consider these names buys at the moment, but if the valuations continue to rise as they have been, I may need to come back here and change my opinion.

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