Has Asia Dethroned Detroit as the Auto Sector Leader?

By: Money_Morning

Martin Hutchinson writes: Back in May I recommended that readers should buy shares in Ford Motor Co. (NYSE: F) on the grounds that the U.S. carmaker would gain market share from the bankrupt General Motors Corp. (OTC: MTLQQ) and Chrysler Group LLC. Ford’s third-quarter profit and healthy October sales growth show I called that one right. One doesn’t like to blow one’s own trumpet excessively, but if you’d followed my advice in May, you would today be sitting on a profit of nearly 50%.

However, while I admire Ford for its brilliant strategic decision not to cave in and accept government-sponsored bankruptcy, and wish it well in its future battles with GM and Chrysler, I’m not sure the company that Henry founded represents the future for the global automobile industry.

More likely – while Chrysler will become a money-pit that is closed only by political means, and GM will limp on as a smaller and marginally profitable U.S. and European producer – Ford will slim down to become a specialty producer of cars tailored to the tastes and needs of the U.S. market. It’s well known that the auto preferences of U.S. consumers differ greatly from those of their European counterparts.

It comes down to this: Ford should be able to make money by limiting its “world car” ambitions and focusing on those needs.

Detroit Will Need to Learn From Asia

In the world as a whole, the big auto story has been the continued advance of manufacturers from China and India.

In China, the cheap-money policy of the People’s Bank of China has helped fuel a continued boom in automobile purchases, to the point that 2009 vehicle sales in China will reach the 11 million mark – making the Asian nation a bigger auto market than the United States.

In fact, even if China were to suffer a recession, that market is likely to remain the world’s largest long-term – despite the fact that the U.S. market will recover substantially from its 2009 lows.

If China has the world’s largest automobile market, we should be paying attention to trends in Chinese manufacturing, because those guys will now possess economies of scale that in the long run should enable that country’s factories to undercut the cost structures of Western manufacturers.

From 10,000 miles away, the most interesting Chinese automobile manufacturer would appear to be Geely Automobile Holdings Ltd. (OTC: GELYF/Hong Kong: 175). Geely manufactures automobiles for China’s domestic market. More interesting, it has specialized in “pastiche” reproductions of famous Western brands, which sell at discounted prices to wealthy Chinese. It has several Mercedes-type models, some Ferraris and other Italian sports cars, and a Rolls Royce/Mercedes hybrid.

Of course, Geely can only do this because of China’s slowly improving, but-still-problematic disregard for intellectual property laws. However, in a world where China is the largest automobile market, it may well be that Geely’s approach to automobile design and manufacture is the wave of the future. Indeed, the ability to manufacture efficiently even in much-shorter production runs may bring this to the U.S. market.

One can imagine a business in which the customer could order a product tailor-made to his or her specifications from a catalogue that includes the broadest possible design cornucopia. If, for example, you want a 1924 Hispano-Suiza H6B, you’ll be able to have one. It makes a Hispano-Suiza H6B noise, and probably rides like the original. But it will also have modern safety features, low maintenance costs and a modern, efficient non-polluting engine.

In the immediate term, Geely has submitted a bid of around $2 billion to buy Swedish automaker Volvo from Ford. From Ford’s point of view, this makes sense.

Ford sold the luxury brands Jaguar and Land Rover to India’s Tata Motors Ltd (NYSE ADR: TTM) last year, having taken the view that high-quality/small-volume automobiles were tough to make money on, and had little synergy with its mainstream business. Selling Volvo would get Ford out of the specialty market altogether, and enable it to concentrate on its core Ford and Lincoln/Mercury brands. The only major impediment appears to be intellectual property: Ford owns a large number of Volvo patents and design specifications and doubtless regards Geely’s insouciant attitude to intellectual property as a threat.

Geely shares trade in the U.S. Pink Sheets, as well as in Hong Kong, and currently trade at about 13 times historic earnings.  But the share price has really run up – to the tune of about 800% – during the past year as the company became better-known to Western investors. At current levels, Geely shares are trading at about twice their inflated 2007 peak price, so investors should conduct their own due diligence and approach the stock with due caution.

India Enters the Picture

China is not the only source of new competition for the United States’ Detroit and Germany’s Wolfsburg. The Indian market has also been expanding rapidly, although it is still only about one quarter the size of the Chinese market.

Tata Motors appeared well placed in early 2008 in that market. However, its Jaguar/Land Rover purchase – made at roughly the market peak – made the company appear very unstable, indeed. Tata’s other new product venture – the Tata Nano, which is designed to sell for 100,000 rupees (about $2,300), a price that’s roughly 40% lower than rival offerings – also was delayed in September 2008, when Tata had to move its proposed manufacturing facility owing to local opposition.

The upshot: Tata looked to be in severe danger last winter.

However, Tata’s earnings in the quarter to September more than doubled from the same period in 2008, on only a 13% increase in revenue. Since the company also raised $750 million in convertible bonds during the quarter, the immediate cash flow worries have largely dissipated.

Moreover, the Nano introduction was a great success. Production is expected to ramp up to 250,000 vehicles in 2010-11, and the car is expected to maintain a large price advantage over competitors for at least a couple of years. Losses at Jaguar/Land Rover also are lessening, so Tata looks likely to survive and grow rapidly in the years to come.

Like Geely, its shares have run-up sharply in the last few months, but look like a sound long-term investment.

In Europe and the United States, the automobile sector looks mature and not very interesting. In Asia, however, there is true growth ahead. Asia also possesses companies such as Geely and Tata, which are trying innovative strategies to capture that growth. As an investor, I prefer to go where the growth is, even if relative prices are higher and risks more substantial.

Money Morning/The Money Map Report

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