Protect Your Stocks Portfolio- Industries to Avoid, Industries to Buy
Companies / Sector Analysis Jul 10, 2008 - 03:06 PM GMTBy: Mike_Stathis
While some of the recommendations in this commentary may seem like no-brainers, its real purpose is to illustrate how investment themes relate to the bigger picture.
U.S. Auto Industry: AVOID
Most of you are familiar with the history of the U.S. automotive industry. If you aren't, all you need to do is look at Detroit 's decline since the 1950s when it once stood as a great city with a strong economy. Once the world's envy, the Big Three became embattled in a struggle between labor unions and foreign imports in the 1980s.
Yet, with more than two decades to respond to competitive threats, the Big Three has shown nothing but disregard for consumer demand. Meanwhile, the bargains struck with the UAW have hastened the effects of free trade. Today, the U.S. auto industry is fighting for a place in line with the airline industry for the next government bailout. At the best of scenarios, they will be bought out and restructured. As it stands today, the U.S. automotive industry is among the worst possible investments in the capital markets. In fact, it has held this title for many years, as the financial statements confirm. Market growth has been MIA, as have growth in dividends.
After the initial flood of foreign autos into the U.S. , labor unions responded with demands for job security and higher wages at the worst possible time. The UAW was able to negotiate a jobs bank and other guarantees that provided full wages in the event of layoffs. A decade later, President Clinton signed NAFTA, which all but ensured the beginning of the end of American manufacturing. After the oil crisis of the 1980s, America became spoiled with very low oil prices; so low that the Big Three overlooked the fuel-efficient strategy of Japanese imports. Instead, they were focused on combating labor unions.
Gradually, foreign autos became known for more than fuel-efficiency. Soon, styling and reliability combined with the toxic effects of unfair trade drew a larger market share. Early on, the Big Three (GM, F) realized it could not compete with the cheap labor overseas. But instead of meeting the competition head on, they chose the route of strategic retreat, which served as a clear indicator of defeat. Soon, the Big Three came to resemble financial institutions more than auto manufacturers. In fact, their financing divisions grew so large that they accounted for most of their profits. Rather than improve the quality and fuel-efficiency of their autos, their strategy was to take advantage of the explosive growth of America 's consumer finance industry in the 1990s.
As well, they embarked upon a huge marketing campaign promoting big trucks and SUVs - something foreign peers had not yet addressed. Slick marketing ads promoting big trucks and SUVs served to make many consumers feel "tough." For many, it worked. But over the past several years, foreign competitors have caught up to the Big Three's marketing gimmicks. Now even Toyota makes large trucks. Now the Big Three focuses on making interest more than making autos. "No money down," and "zero percent financing" serves as the line by most U.S. auto dealers.
With gas prices on a strong upward trend for several years now, the Big Three continue to run away from viable solutions. Instead of designing stylish, fuel-efficient autos, they are now producing hybrid SUVs as a solution to the oil crisis! The fact is that hybrids are for the most part a scam. Consider these facts. Although there are a few exceptions, most hybrids only offer an additional 5 or 6 MPG, while costing thousands more. And you can't count on breaks since they are limited to the first 50,000 to 60,000 vehicles sold. As well, Bush phased out tax incentives for hybrids. Needless to say, it's a poor consumer decision to buy a hybrid given the poultry benefit and the uncertain risk of the new hybrid technology. But it gets worse. The MPG listed on U.S. autos has been proven to significantly underestimate the actual MPG for a variety of reasons. This has fooled consumers into thinking that their truck or SUV gets better gas mileage than in reality.
Now the latest scheme is Ford's offer to cap the price of gas to new buyers of their trucks for three years. The price has been set at $2.99/gallon, regardless where gas goes over this period for up to 12,000 miles per years. How many of you drive only 12,000 miles per year? Basically it's another gimmick to entice consumers to be stuck with a huge financial liability. Let's do some simple math. Let's assume that over the next three years, gas averages $4.00 per gallon. That's about 700 gallons covered per year or about $2100 savings. We all know how auto dealers play games with prices and promotions; trim the price here a few thousand, while increasing the financing, etc. They manage to juggle the promotions so the net cost will be the same. But since the average annual mileage driven in the U.S. is about 25,000 miles, you're still going to feel the pain of higher prices at the pump to the tune of over $2200 each year (assuming gas averages $4.00/gallon).
And what are you supposed to do after three years? I suppose U.S. auto dealers will have a "loyalty program" for you to trade your truck in for another similar deal. We all know that the more frequently you sell an auto, the higher percentage of your lifetime auto costs go to sales commissions. Anyway you look at it, the U.S. auto industry is a big joke. It's become an embarrassing reality that Americans have come to accept over the years. In contrast, foreign auto makers don't need to offer 0% financing because consumers are drawn to their autos for the right reasons – styling, quality, reliability, fuel-efficiency, and value.
But labor costs have also hit the Big Three hard for many years. Certainly their pension plans are hurting while GM and Ford report massive losses. And they've had to buy out thousands of workers who had guarantees despite plant closings. And they still haven't fully dealt with the jobs bank liabilities. As a result they are paying thousands of laid off employees NOT to work. It's remarkable they have been able to stay in business this long. If this weren't enough, the biggest labor costs of the Big Three are healthcare benefits. For each auto that rolls off the assembly line, GM is already in the red by over $2200, most for healthcare benefits; the remaining for pension payouts.
So how is it possible the Big Three has been able to survive this long? After all, they have unmanageable labor costs while their products have continued to ignore consumer demand. If it weren't for their financial units they may have been gone long ago. But perhaps the main reason why the Big Three has continued to exist is that it has been able to sell cars Americans don't want to government entities, police departments, corporations, and car rental companies. Have you ever wondered why for so many years it was impossible to rent a Japanese car at one of the big car rental companies? Only recently have they been made available. But still they don't have many foreign cars.
According to the Detroit News, Enterprise Rent-A-Car alone accounts for about 7% of the Big Three's auto sales each year. Imagine if these deals weren't struck with car rental companies, police departments and other government bodies to encourage them to buy American autos. When you have a certain amount of guaranteed auto sales from government entities, car rentals and corporations, it doesn't exactly make you have a sense of urgency to address consumer demand. Certainly, the previous deals stuck with the UAW, as well as the unfair trade laws have made the U.S. auto industry a losing proposition. However, the management has been lazy and irresponsible, focused more on protecting their jobs.
Oil Industry: BUY
Recently, we've heard Hillary and McCain's "solution" to soaring gas prices. They want to give Americans a federal gas tax vacation over the summer. That would be a savings of $0.18 per gallon. Over the proposed three-month period, a total savings of about $60, assuming one drives 25,000 miles per year in a car that gets 20 MPG. These quick fixes are a slap in the face to all Americans. And it confirms the position of these candidates. They refuse to go up against corporate America . All they do is pander. A couple of years ago Bush used a similar gimmick to avoid addressing the extortion by oil companies – mandating an ethanol gas blend. And we all know what that has done to food prices. In fact, not only has the use of ethanol NOT decreased the price of gas, but it's even caused gas prices to rise since corn prices are so high now. It seems to me that a real solution would be to regulate the profit margins of the oil industry. How is it possible that oil companies are recording record profits under record oil prices? The only way it's possible is if they're keeping the same profit margins amidst the oil crisis. Since oil is absolutely needed for consumers and businesses, doesn't seem as if during a crisis, oil companies should absorb some of the pain and reduce profit margins? Why should oil companies be permitted to earn record profits while the rest of the economy gets abused?
The distribution of basic necessities should be controlled by the government or at least highly regulated to minimize consumer exploitation. Cities understand this. That's why they run water services rather than leave it up to for-profit companies. It is also why the government controls the agricultural industry via subsidies. We already saw what happened to the utilities industry when Washington let the free markets take control – Enron. If you permit for-profit companies control the distribution and sale of a basic necessity, should you allow these companies to hoard profits during the most severe oil crisis in the history of the U.S. ? Oil companies already enjoy the most generous tax breaks of any industry. They want it all and they're getting it. Meanwhile, consumers are getting abused. And Washington sits around pretending they don't like it but no one is doing anything about it. They aren't even coming up with reasonable solutions! In conclusion, America 's oil industry resembles a monopoly. And monopolies always control their profits because we have no choice but to pay what is asked since rationing has its limits. If you haven't already invested in oil, you need to because we have seen the end of cheap oil for a long time.
Healthcare: BUY
The strategy of the Big Three reminds me of how Bush has addressed the recession with $600 checks – money that must be borrowed from China . And of course, most of that money has already been spent on higher gas prices. Washington addresses America 's oil and healthcare crisis in the same manner, confirming how stupid they think we are. Bush did the same thing when he passed Medicare Part D. His implied message was "seniors, I feel your pain from the high price of prescription drugs so I'm going to let all Americans subsidize the cost of drugs while letting the drug industry (RXL, PFE, MRK, BMY, GSK, KG) continue to charge what they want." Yet, the only ones who stand to benefit from Part D are the drug companies. Bush did the same thing with Medical Savings Accounts (MSAs). Rather than address the hyper-inflation in medical insurance premiums, he offered a tax deduction to those who contribute money to these accounts. You don't fight fire with fire.
Taxpayer subsidies do nothing to address the biggest problem with healthcare – rising costs. Already, America spends 18% of GDP on healthcare costs, and roughly half of this comes from government spending. What about Americans who lost their jobs to outsourcing? If you think they will automatically qualify for Medicaid you are very wrong. According to the CMS website, "Medicaid does not provide medical assistance for all poor persons. Even under the broadest provisions of the Federal statute (except for emergency services for certain persons), the Medicaid program does not provide health care services, even for very poor persons, unless they are in one of the designated eligibility groups."
This, my friends is why 50 million Americans have no access to medical insurance. And if you think you are covered because you have full insurance (IHF, PTJ, XLV, WLP, WCG, UNH, HUM, AET, CI, HWAY), consider that 30% of medical bankruptcies are with consumers who have insurance. Are we that stupid not to see what's going on?
While McCain is absolutely clueless as to the dire consequences of America 's healthcare crisis, Obama and Hillary have fooled most Americans by offering what they have labeled as a universal plan. The fact is, neither of these plans is universal; period. A universal healthcare plan is a single-payer plan, meaning there is only one payer, such as the government or a private provider. Whether you are in favor of a universal plan or not, the fact is that promises of healthcare access are quick fixes that are not sustainable without some level of price controls. Thus, the issue that must be addressed is cost containment. Some form of price controls is absolutely vital. Without price controls, Americans will continue to subsidize costs of prescription drugs for the rest of the world. Money to feed America 's inefficient profit-driven healthcare machine has to come from somewhere. If it comes from Washington , you'll see higher taxes in some way shape or form. If it comes from employers, you'll see the effects in terms of lower wages (slower raises) or decreases in other benefits.
You can't cheat the system. Along with the oil industry, America 's healthcare system controls the distribution of services that are considered basic necessities for a modernized world. When for-profit companies are free to control pricing of goods and services absolutely needed by consumers, this will ultimately result in unrestricted price hikes and diminished quality. That is the current state of healthcare in America , now ranked 37th by the World Health Organization. But America 's healthcare does hold one distinguished title – it's the most error-prone system on earth. In fact, medical errors now account for the number three cause of deaths in the U.S. (1) Similar to the oil industry, America 's healthcare industry resembles a monopoly more than a free market system. Thus, investments in the drug and medical insurers are positioned to do quite well over the next several years, especially when 80 million aging baby boomers develop chronic disease – the most costly of all medical expenses.
Airline Industry: AVOID
Before government deregulation in the late '80s, there were over 200 U.S. airlines. That's right; over 200. That was at a time when you had a lot of competition. Since that time, most have gone bankrupt. Today, we have a small handful. And each one is flirting with bankruptcy without government help. A few years ago, the airlines already received a government bailout and another is just over the horizon. There is no way the airlines will be able to stay in business with oil at over $100 per barrel.
Not only is the airline industry (AMR, DAL, NWA and LUV) subject to the vulnerability of oil prices, but the management is pathetic. Other than Southwest Airlines, they have a terrible corporate culture and they aren't even able to effectively lock-in oil prices using futures. If you take a look at the balance sheets of the airlines you will see that they do not build equity. They don't even own their jets. They're mostly operating leases. So what are buying when you purchase these stocks? Are you getting a real business with real assets with the prospect of real growth? Or are you investing in ticket sales for the next flight? Wall Street isn't going to tell you the reality – U.S. automotive and airline industries are absolutely terrible investments, because they want the big investment banking business these industries provide.
Friends, you won't find a person that embraces the free markets more than me. I have worked on Wall Street, run my own business and I currently work in the venture capital industry. These are among the most entrepreneurial settings on earth. But I support a free market system that is fair and without the extreme corruption we see today. Without a proper system of capitalism - one that is regulated appropriately to ensure fraud is punished - the system is no good because it only benefits the guys at the top, while serving to keep everyone else down.
How long will consumers allow Washington to unfairly enrich corporate America using taxpayer dollars at the expense of working-class Americans? Maybe now you know why the U.S. media continues to dumb-down Americans. Perhaps if they are constantly talking about Paris Hilton or the he-said-she-said between Hillary and Obama, maybe Americans won't stop to realize they have lost their nation to mega-corporations and their jobs to Asia , as they struggle to pay for basic necessities.
Government bailouts reinforce a moral hazard. Companies take on huge risks or else sit on their butts knowing that taxpayers will be forced to bail them out. Yet, they benefit from an unregulated free-market system that promotes taxpayer and shareholder fraud, huge executive payouts, and virtual monopolies. The recent bailout of the financial industry will only ensure another catastrophic meltdown in the future because the banks know there is no real penalty for failing. Washington should let the banks that acted irresponsibly fail, as it should the airlines and auto industries. Real free market entrepreneurs would come in and run these industries the right way, knowing that their money is on the line. The fact is that our previously great system of capitalism has been transformed into a gravy train for large corporations. Today, America 's economic policies resemble fascism more than capitalism. Industry lobbyist groups have cemented this dysfunctional economic policy, buying off politicians with billions of dollars in donations and bribes each year. Take a look at the amount of money flooding into Washington over the past few years from the 3 most profitable industries in America .
Lobbying By Industry, 1998-2004: (2)
• Oil & Gas Companies: $343,896,623
• Total Healthcare: $1.38 Billion
•Miscellaneous Health Interests: $53,028,250
•Health Professionals: $307,285,813
•Pharmaceuticals & Other Health Products: $673,701,988
•Total Finance: $760 Million
•Commercial Banking Institutions: $216,732,440
•Finance & Credit Companies: $94,313,706
•Miscellaneous Finance: $118,451,264
•Securities & Investment: $330,514,589
War Profiteers: Let Your Moral Compass Decide
If you already haven't gotten in on more of Washington 's monkey-business and you don't have an ethical conflict, you might want to consider investing in some of the war profiteers supported by Washington : HAL, KBR, LMT, BA, CAI, LLL, and FLR. I'm actually surprised no one has created an Iraq-related ETF consisting of these and other companies. I personally refuse to profit from the fraud and extortion exhibited by some of these companies. However, I'll take pleasure in possibly shorting them if Hillary or Obama wins the election, as that might put an end to their string of record earnings due to the conflict in Iraq .
In conclusion, I have never recommended the purchase of any U.S. auto or airline stocks to any of my clients, nor have I ever purchased them even for a trade. And I don't ever plan to. There are simply too many investment/trading opportunities with better risk-reward ratios. Once again, I prefer the oil trusts (PGH, PWE, PBT, and HTE) to provide income during a volatile market. Some even represent decent opportunities for short-term trading. As well, long-term investors will stand to benefit by building positions in the beaten-down HMO and drug stocks. If you are going to get abused as consumers by the effects of hyper-inflation seen in America's oil and healthcare monopolies, you may as well seek to make back some of this money by investing in them. But there's no rush. Be patient, as the market is sure to head lower over the next few months. And a correction in oil prices of 20-30% over a 3-month period is certainly consistent with the volatility characteristics of this commodity.
Sources
(1) http://www.bostonreview.net/BR30.6/starfield.html
(2) Center for Public Integrity
Disclosures: as of the date of this article submission, Mike owned the following stocks mentioned: PGH, PWE, HWAY, PFE, and KG (only on valuation, intended for intermediate-term trade). Other asset classes not mentioned here but recommended: precious metals, Asian and Latin American funds, and foreign currencies.
By Mike Stathis
Copyright © 2008. All Rights Reserved. Mike Stathis.
Mike Stathis is the Managing Principal of Apex Venture Advisors , a business and investment intelligence firm serving the needs of venture firms, corporations and hedge funds on a variety of projects. Mike's work in the private markets includes valuation analysis, deal structuring, and business strategy. In the public markets he has assisted hedge funds with investment strategy, valuation analysis, market forecasting, risk management, and distressed securities analysis. Prior to Apex Advisors, Mike worked at UBS and Bear Stearns, focusing on asset management and merchant banking.
The accuracy of his predictions and insights detailed in the 2006 release of America's Financial Apocalypse and Cashing in on the Real Estate Bubble have positioned him as one of America's most insightful and creative financial minds. These books serve as proof that he remains well ahead of the curve, as he continues to position his clients with a unique competitive advantage. His first book, The Startup Company Bible for Entrepreneurs has become required reading for high-tech entrepreneurs, and is used in several business schools as a required text for completion of the MBA program.
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