Lower Risk Makes One Auto Giant A Buy And Another A Sell

| About: General Motors (GM)

The auto industry has been the standout this year contributing strongly to industrial production and sales reports. Wednesday brings the data on last month's vehicle sales and investors get quarterly results from the world's top selling automaker on Thursday. While demand remains strong, increased competition could continue throughout the year.

Demand Moderating but Still Strong

After dropping sharply in May, light vehicle sales rebounded in June and are expected to continue strong into July. Domestic sales increased from 10.6 million to 11.1 million, the strongest reading since February. We are forecasting total vehicle sales to come in at 14.0 million, bringing the three-month average down to just under 14.0 versus 14.1 million in the April through June period. Even as light vehicle sales increase more than 15% over last year, they are still down dramatically from 17.4 million in 2000 and contributing to a building consensus that demand will remain high as the existing vehicles in use get older.

Moderation in the price of gasoline has taken some of the headwinds out of light truck sales which were up sequentially from March to June.

Industry executives reported a strong environment in a recent KPMG survey as the average age of vehicles in the U.S. hits an all-time high of almost 11 years. North America was singled out as the primary growth market with China and Latin America strong as well. Sales in Europe will probably fall for the fifth consecutive year to just above 13.0 million this year.

Increased Competition from Overseas

Automotive retailer AutoNation (AN) reported record earnings in the second quarter on a rebound in sales for cars made out of Japan. The big three automakers have largely come back from the production shortage caused by last year's massive earthquake. Revenue at the country's largest dealership chain increased by 17% to $3.9 billion off of a 44% surge in sales of cars from Toyota Motor (TM), Nissan Motor (OTCPK:NSANY) and Honda Motor (HMC).

Competition in the U.S. for market share among the automakers may increase this year as Europe continues to be a loss on production and China looks to slow further. Increased production over last year from Japanese makers should bring supply up sharply. Sales of autos in the United States were 7.27 million in the first half, an increase of 15% over last year, and could reach 14.2 million for the year.

Ford Motor (F) beat estimates for second quarter earnings but profits in were lower in every region except North America. Volume was up 4.4% in North America with revenues up 1.0% over last year. Volume in Europe was down more than 15% with revenues down 21%. The company described the problem in Europe as structural and guided full year loss to above $1 billion on volume and a lower market share. Volume in South America was also down 23% with revenues down 21% on higher costs and foreign exchange pressure.

General Motors (GM) decision to offer a buyout to salaried pension holders and transfer its U.S. salaried pension risk to an annuity was big news. The company is transferring about $26 billion of pension obligations and $29 billion in pension assets for the annuity. It will end up paying about a 10% premium to the funded status to unload the risk and will need to take a one-time special charge later this year. This will hit earnings but the stocks multiples should increase because of the substantially better risk profile. GM is expected to post $0.74 per share earnings when it reports on August 2nd on revenue of $38.6 billion.

On multiples, both Ford and GM look cheap trading at just 7.4 and 5.0 times trailing earnings. Investors are paying only 1.0 times EBITDA for GM and about 3.0 times for Ford. While Ford has been the stronger company over the last few years, GM looks more attractive on a valuation basis and for the higher multiples warranted from the changing risk profile. With most regions outside the United States looking weak, investors may want to hedge a long position in GM with a short in Ford to offset some of the industry risk.

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

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