- Auto sales have been declining since last year.
- Ford sales fell more than GM's.
- I hope that the current Administration does not renegotiate the NATFA. Otherwise, automakers will pay the consequences.
Exactly a year ago, I wrote an article suggesting that investors reconsider their long positions in General Motors (NYSE: NYSE:GM) and Ford (NYSE: NYSE:F). It is time to measure the results and to reassess my view on both stocks.
The performance of my sell recommendation.
Under the capital asset model pricing and for the last 12 months, Ford should have returned 25%, and GM should have returned 31% considering that the market returned 22%. I took the 10-year Treasury bond at an average of 2%. While investors can argue that a long position in GM was profitable because it generated a 23% return, the reality is that GM underperformed the S&P 500. Ford was a disaster because it had a negative return.
In short, investing in the S&P500 was better than investing in Ford or GM on a risk-adjusted basis. The only exception was if an investor was a risk-neutral who seeks return only.
The auto sales outlook
The near future of auto sales is gloomy today. Since 2016, auto sales have been declining on a monthly basis YOY. Moreover, there are no indications that the negative trend will reverse. I believe that one of the reasons for declining car sales is the sustained low gas prices. If consumers can get cheap gas, fuel economy is not a priority. Therefore, I expect a weakening demand for cars and a stronger demand for SUVs and trucks. The World Bank projects relatively stable crude oil prices for the foreseeable future. Therefore, I expect a demand shift from cars to SUVs and trucks.
The increasing interest rates may also be impacting auto sales to some degree. If interest rates continue to rise, fewer consumers are willing to finance new vehicles. Instead, consumers have the option to pay for a used car in cash and avoid an auto loan.
An interesting phenomenon that is happening this year is that domestic car sales have declined less than foreign car sales. In 2016, demand for imported cars was much stronger than for domestic vehicles. Therefore, I would avoid investing in Toyota (NYSE: TM) Honda (NYSE: HMC).
Ford and General Motors
In June 2017, Ford posted a whopping 23% decline in car sales led by a 36.7% decline in Mustang sales, 31% decline in Fusion sales, and 20% decline in Focus sales. The Ford SUV sales jumped by 2.9% in June on a YOY basis largely aided by stronger demand for Ford Edge and Ford Explorer. The Ford F-series sales also increased by 9.8%. Meanwhile, Ford Van sales declined sharply by more than 25%.
Source: Ford June 2017 sales report.
General Motors fared slightly better. GM’s total sales dropped by 4.7%, better than Ford’s sales decline of 5.1%. Buick experienced a strong demand for the Envision model. Sales of luxury cars, Cadillac, dropped by 11.8%.
Source: GM June 2017 sales report.
Potential headwinds in the auto industry
Ford and General Motors produce many of their vehicles in Mexico, and President Trump is promoting the idea of renegotiating the NAFTA. If this event occurs, it will affect automakers who produce cars overseas. Also, if Ford and GM bring their plants back to the United States, profitability will decrease without a doubt. If the interest rates continue to decrease, you should expect auto sales to continue declining.
According to Marketwatch.com, the average recommendation on Ford is “Hold” with 26 analysts covering the stock. The price target is $12.77. GM has an average overweight recommendation with a price target of $39.66.
I think that investing in the auto industry is not a plausible proposition now. Auto sales have steadily decreased over the past two years. While you may argue that the potential surprise is to the upside regarding auto sales, it is best to wait for the trend to reverse. If you want to invest in the auto industry despite the negative outlook, I would do a pair-trade with a long position in GM, and a short position in F because GM has fared better in turmoil. Moreover, I would avoid all foreign automakers at all costs until the demand for foreign cars improves.
Disclaimer: I created all of the graphs herein presented except as disclosed.
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