Are These Auto Stocks' Headwinds Making Them Unattractive?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It seems that automakers are all pinning their growth hopes on China. Investors should cringe at an industry where many of the biggest companies are rushing into the same market. Such rivalry will drop margins.

Worse yet, investors should shy away from U.S. automakers because of their leverage, and Japanese automakers based on their currency exposure.

Japanese Investment In China

The worst seems to be over for foreign car makers in the People's Republic of China. Honda (NYSE: HMC) and Toyota (NYSE: TM) are continuing to expand in China, the world's largest auto market. Toyota says that it will introduce 20 new models in the coming three years in the country. An analyst at industry researcher IHS Automotive, Namrita Chow said,

"In 2013 Japanese brands will go all out to regain any lost ground encountered in the fourth quarter of this year. This will mean new model launches, discounts and good service packages as well as an increased lineup of models on offer to consumers in China."

In September and October anti-Japanese sentiment among Chinese consumers cooled and orders have stabilized at 80% of last year's numbers. Additional improvements to the relations between these two countries should translate into more sales for Japanese automakers.

Meanwhile, Volkswagen and General Motors (NYSE: GM) believe that they will continue to grow faster than the industry in China. Volkswagen's China chief Jochem Heizmann says, "Every business, every brand is selling especially well. Next year's growth won't be at the past five years' rate, but China will continue to grow, at a healthy, rational, mild growth rate which is better for the Chinese market's development."

German Investment in China

Not to be outdone, Germany-based Volkswagen (NASDAQOTH: VLKAY) aims to become the world's biggest automaker by 2018 with aggressive expansion plans in China. Volkswagen sells three brands: Volkswagen, Audi, and Skoda, which account for 20% of China's passenger vehicle sales, far ahead of General Motors, Buick and Chevrolet at 9.9% percent, and Hyundai Motor with 9.7%.

VW intends to spend 9.8 billion Euros ($12.6 billion) in its Chinese ventures until 2015, in a strategy targeting China's next wave of first-time car buyers who have yet to establish brand allegiance. This is close to double GM's $7 billion capital spending in the region. Beijing market researcher Synergistics president Bill Russo said, "Chinese consumers are notoriously disloyal. Volkswagen's challenge is continuing to build customer relationship management, and be geographically in the high-growth regions."

VW's early entry into China had previously established outlets in bigger developed cities, and now the German carmaker wants to expand in smaller cities where demand is forecast to account for 60% of new car deliveries by 2020, a leap from 40% in the past decade. Growth in car sales for cities considered as third and fourth-tiered is likewise predicted at an annual 10% by the end of the decade, in contrast to a 4% yearly increase in Beijing and Shanghai.

VW's Chinese joint ventures with SAIC Motor and China FAW Group will increase the number of operating factories in China to 11, with targeted annual capacity of 4 million vehicles by 2018. A new plant in Changsha, Southern Hunan province with a 300,000 unit capacity is also being considered. Negotiations for extending the JV with FAW are on-going. The joint venture manufactures the Jetta sedan and the Audi A6L, stretched luxury models that appeal to Chinese buyers.

Volkswagen's sales in China now comprise about 30% of its total global output. Norddeutsche Landesbank analyst Frank Schwope explained, "For 60 years, the most important market for VW was Germany; they sold around 1 million cars there. Four or five years back, China overtook the German market. Now VW is still going to sell 1 million cars in Germany, but 2.7 million cars in China."

Despite this optimism, Volkswagen has shortened its investment calendar. Management feels that long term planning is becoming more difficult because of market uncertainty. A Frankfurt-based Bankhaus Metzler analyst said, "There are a number of uncertainties globally. They may want a certain degree of flexibility, more than in the past, because there is room for quite dramatic changes in the market conditions." He recommended buying the stock.

As forecasting is becoming more and more difficult, Volkswagen will be announcing a three year investment timetable. In order to cut costs, the company is planning to introduce 40 models which will be of the same framework of its brands and best selling vehicles: Seat and Skoda. The company will also focus on expanding production and model spending. Works council head Bernd Osterloh says, "The agreed investment is a clear indicator of the security of jobs and employment at Volkswagen in the face of the difficult industry environment." The company also says that they are investing more than before to reach their long term goals.

Financial Metrics

If the automakers are all vying for the same market, I would need to see special incentives to get involved as an investor. This means that I should see remarkably low valuations and solid balance sheets for automaker stocks.

Consider the following financial values:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Country</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>P/FCF</strong></p> </td> <td> <p><strong>D/E</strong></p> </td> </tr> <tr> <td> <p>F</p> </td> <td> <p>Ford</p> </td> <td> <p>USA</p> </td> <td> <p>2.59</p> </td> <td> <p>0.32</p> </td> <td> <p>2.33</p> </td> <td> <p>10.97</p> </td> <td> <p>5.34</p> </td> </tr> <tr> <td> <p>GM</p> </td> <td> <p>General Motors</p> </td> <td> <p>USA</p> </td> <td> <p>9.73</p> </td> <td> <p>0.27</p> </td> <td> <p>0.97</p> </td> <td> <p>38.6</p> </td> <td> <p>0.4</p> </td> </tr> <tr> <td> <p>HMC</p> </td> <td> <p>Honda</p> </td> <td> <p>Japan</p> </td> <td> <p>14.87</p> </td> <td> <p>0.55</p> </td> <td> <p>1.11</p> </td> <td> <p>NA</p> </td> <td> <p>0.92</p> </td> </tr> <tr> <td> <p>TM</p> </td> <td> <p>Toyota</p> </td> <td> <p>Japan</p> </td> <td> <p>14.97</p> </td> <td> <p>0.57</p> </td> <td> <p>1.04</p> </td> <td> <p>33.82</p> </td> <td> <p>1.09</p> </td> </tr> </tbody> </table>

Honda and Toyota are based in Japan. Yen-dependence means that their low price-to-book ratios are not exciting, since they are denominated in an overpriced currency. These firms are also problematic in that any Yen-strengthening would make their cars more expensive and less competitive.

Ford (NYSE: F) is too highly-leveraged for consideration based on its debt-to-equity valuation. General Motors is taking steps to lever itself as well by initiating a large line of credit and pursuing financial acquisitions. Investors should expect its debt-to-equity ratio to grow rapidly.

Overall, these companies do not provide entry points that are compelling enough for me jump into this highly competitive industry.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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