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How to Protect your Wealth by Investing in AI Tech Stocks

Why the 'Big Money' Still Believes in Auto Stocks

Companies / US Auto's Jan 14, 2015 - 03:32 PM GMT

By: Money_Morning

Companies

Michael E. Lewitt writes: U.S. auto sales were up big in 2014 and are expected to stay strong in 2015:

Oil prices have collapsed and are expected to stay low, fueling demand for pickup trucks, SUVs and RVs…

The average age of the U.S. auto fleet is at a record high 11.4 years while the average age of a full-size pickup truck is an even older 12.5 years according to industry analysts Polk….


Auto financing is readily available…

Indeed, all the signs of a boom time for the American auto industry appear aligned, yet auto stocks are trading at depressed values compared to the rest of the stock market.

Are auto stocks ripe to buy, or are they simply an investor's value trap? Here's the real answer.

These Value Metrics Scream "Bargain"

Continuing my series on solid American companies trading at reasonable prices, it would seem that the auto sector would be an excellent place to look for value (a positive for Thor Industries, Inc. (NYSE: THO), a company I wrote about a few weeks ago).

Indeed, a quick look at the easiest valuation and yield measures available to digest suggests investors should flock into auto stocks.

General Motors Co. (NYSE: GM) and Ford Motor Co. (NYSE: F) trade at 0.36x and 0.41x sales, respectively, while the S&P 500 is trading at 1.8x sales.

GM and Ford stock trade at 9x and 9.7x estimated 2015 earnings (per Barclays), respectively, while the S&P is trading at 16x for the same period. GM pays a 3.4% dividend with a 48% payout ratio, while Ford stock pays a 3.9% dividend with a 60% payout ratio.

In a world where the 10-year Treasury yields under 2%, these are extremely attractive yields.

This has drawn the attention of some impressive investor names, all of whom have

piled into GM and Ford stock with disappointing results.

GM stock declined from $40.87 to $34.91 during 2014, a 14.6% drop, on the back of a series of embarrassing product recalls.

Meanwhile, F stock was basically unchanged on the year. Among those licking their wounds on their investments are Kyle Bass, David Tepper, Marty Whitman, Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

When value investors see stocks trading at huge discounts to book value and at low P/E ratios, they can't help themselves. But maybe these stocks are cheap for a reason. Maybe they are a value trap…

This Sector-Wide Problem Looms Large

Those who are negative on the auto industry argue that an explosion in subprime auto loans, which now account for 25% of new car loans, has artificially inflated sales.

Many unworthy borrowers are accessing credit at high rates and will end up defaulting. There are signs that delinquencies could soon be a problem affecting the industry. While only 0.71% of all subprime loans were delinquent in November 2014, more than 2.6% of borrowers who took out loans in the first quarter of 2014 had missed one monthly payment by then. This was the highest level of early loan trouble since 2008 when delinquencies rose above 3% according to an analysis performed by The Wall Street Journal and Moody's Analytics.

As of the third quarter of 2014, 3.4% of all auto loan borrowers had missed at least one car loan payment compared to 3.2% a year earlier. This compares to 4.2% in 2009 at the height of the recession according to Experian Automotive

Missed loan payments could not only hurt companies like Ally Financial, Inc. (NYSE: GOM.CL) and other lenders, but could impact GM, Ford, and other automakers if lenders begin to tighten lending standards. There are many loosely regulated finance companies that have crowded into this space that have been able to borrow cheaply in the junk bond market, and while likely not a systemic threat (the overall subprime auto market is only $900 billion in size), this area could easily become another casualty during the next recession or economic crisis.

New Players Face Novel Issues

Of course, there's now more to the auto industry then the old-line standard bearers, and they factor into the sector's valuation and investment choices, too…

GM and Ford look particularly cheap in comparison to upstart Tesla Motors, Inc. (Nasdaq: TSLA). Tesla trades at infinity-times earnings (as it has never turned a profit) and has a stock market capitalization of nearly $26 billion compared to roughly $57 billion for GM and Ford.

In 2014, GM turned out roughly 27,000 vehicles per day; Tesla was trying to produce that many cars a year. Wall Street analysts are fighting with each other to come up with new estimates for how high TSLA stock can rise based on new valuation metrics that hearken back to the Internet bubble. Tesla is precisely the kind of stock that investors should not be buying in a highly extended stock market.

In contrast, GM and Ford shares are better insulated against a stock market correction because of their low valuations. The real issue is that they are vulnerable to an economic slowdown that is increasingly probable in light of the flattening yield curve and collapse in long-term interest rates and commodity prices.

With auto sales at extremely high levels, one has to wonder how much higher in price they can go in the near future, and more importantly, which auto stock we can look to for long-term value and profit.

Here's How to Play Auto's Long Term

Today GM looks more attractive than Ford from a value standpoint.

GM appeared to be heading toward full investment grade credit ratings in 2014 until it was driven off the road by the ignition switch recall. It appears that the company has handled that problem while maintaining its market share, its strong liquidity (about $26 billion of cash and equivalents on its balance sheet plus $12 billion of unused bank revolvers), and strong sales.

GM's Debt/EDITDA is a low 1.0x and, adjusted for its still considerable pension obligations, is a still solid 2.5x.

In comparison, Ford is more leveraged with a Debt/EBITDA ratio of 1.7x and equivalent pension-adjusted leverage of 2.4x. Ford's balance sheet debt is $14.9 billion compared to $10.9 billion at GM.

GM is unlikely to stage any significant stock buybacks over the next year until it is past the recall-related costs. As a result, the stock is likely to perform in line with the S&P for the foreseeable future.

It is attractive as a long-term holding, however, which is likely why some of the smartest value investors in the world haven't given up on it.

Source : http://moneymorning.com/2015/01/14/why-the-big-money-still-believes-in-auto-stocks/

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