Automakers Weighed Down By Increased Leverage, Supply Chain Issues

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

I don’t see compelling values among automakers. Consider their financial metrics:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>D/E</span></p> </td> </tr> <tr> <td> <p><span>F</span></p> </td> <td> <p><span>Ford</span></p> </td> <td> <p><span>2.6</span></p> </td> <td> <p><span>0.32</span></p> </td> <td> <p><span>2.34</span></p> </td> <td> <p><span>5.34</span></p> </td> </tr> <tr> <td> <p><span>GM</span></p> </td> <td> <p><span>General Motors</span></p> </td> <td> <p><span>9.57</span></p> </td> <td> <p><span>0.26</span></p> </td> <td> <p><span>0.96</span></p> </td> <td> <p><span>0.4</span></p> </td> </tr> <tr> <td> <p><span>HMC</span></p> </td> <td> <p><span>Honda</span></p> </td> <td> <p><span>14.75</span></p> </td> <td> <p><span>0.55</span></p> </td> <td> <p><span>1.12</span></p> </td> <td> <p><span>0.92</span></p> </td> </tr> <tr> <td> <p><span>TM</span></p> </td> <td> <p><span>Toyota</span></p> </td> <td> <p><span>14.97</span></p> </td> <td> <p><span>0.57</span></p> </td> <td> <p><span>1.05</span></p> </td> <td> <p><span>1.09</span></p> </td> </tr> </tbody> </table>

Honda (NYSE: HMC) and Toyota (NYSE: TM) trade at earnings multiples above the S&P 500 average. These Japanese automakers are also recovering from Chinese boycotts and riots against Japanese companies.

Ford (NYSE: F) is so highly levered that it seems like a financial services company.

This leaves General Motors (NYSE: GM), though investors should pass on it for reasons that are not captured in financial metrics that are based on past performance. The firm is moving toward more leverage and is having problems in its supply chain which endanger end-of-year and 2013 profits.

GM Production Line Problems

There are General Motors supply chain issues that could lower its earnings and shoot up its P/E ratio. The firm is planning to reduce its production or possibly slash prices as a result of a pipeline of trucks that is double its typical number. Currently, the company’s focus is to clear that inventory to make room for crucial new models. The new versions of the Chevrolet Silverado and GMC Sierras set to be launched in 2013 are at stake due to high inventories. The new models, especially big trucks, will be key to the company’s success in 2013. One of the most profitable models was big pickups, which contributed about 23% of its US sales last year.

Baum & Associates’ principal auto-industry researcher, Alan Baum, said, “If they continue to have these high inventories and then bring out the new product, that’s going to hurt the launch of new vehicles’. The company could further reduce its pickup production during the first quarter next year by approximately half. The production would fall to 106,000 from 210,000 as compared to year earlier until the new trucks would be released off the assembly lines during the second quarter.

A projection from October warned that the company would have to pare back its first-quarter truck production by 35,000 according to Brian Johnson, an industry analyst at Barclay’s. This decision could cost about $1 billion in revenue.

Currently, the main focus of the company would be to deal and clear off its high inventory level. The sales of Chevrolet Silverado declined to 30,674 last month, representing a fall of 10% as compared to year earlier and the sales of GMC Sierra declined to 11,726, representing a decline of 2% as compared to year earlier.

Some of the high inventory maintenance was a part of the company’s strategy, to maintain a continuous supply of trucks even when it switched tools at its factories to upgrade them for the new pick-ups. The company announced about a year ago that it plans to close down production for 21 weeks at its three full-sized truck plants in 2012 for upgrading its factories. It planned to have 80 to 85 days’ supply on a selling-day adjusted basis by selling down its inventory to 200,000 to 220,000.

IHS Automotive has its doubts about older production forecasts. Earlier it estimated that the company would build 210,000 pickups during the first quarter according to Tracy Handler, an analyst in Michigan. She also said that “they really want to protect themselves from having no trucks if anything were to go wrong.” at the time of commencement of production of the redesigned pickups during the second quarter.

The company’s pick-up inventory increased to 245,853, representing an increase of 4.4% from a month earlier by the end of November. According to Kurt McNeil, Vice President of Sales Operations, its inventory goal is in jeopardy. Currently, its total inventory goal has increased from 650,000 vehicles a month ago to 660,000-670,000 vehicles. He also said that they will not go beyond 220,000 levels. It can also adopt a strategy to offer incentive to sell some more trucks according to various analysts.

But in November, the company decreased its incentive spending on pickups as compared to previous year. Average spending on the Silverado declined to $3,988 per unit as compared to $4,459 a year ago and average incentive spending Sierra declined to $4,226 per unit from $4,801 as compared to previous year.

General Motors is Gearing Up

Investors should be worried by how General Motors is borrowing and acquiring more financial operations because it went bankrupt in the financial crisis. This is like seeing a pyromaniac playing with matches. Past bankruptcy is a bad indicator of future financial stability, and acquisitions and debt financing do not make firms more stable.

General Motors’ financial subsidiary is buying Ally Financial’s European and Latin American operations for $4.2 billion. This follows similar sales by Ally Financial for Canadian and Mexican operations in May in efforts to raise funds for faster repayment of U.S. bailout funds. 

General Motors made this acquisition to strengthening its in-house financing operations. General Motors CFO Dan Ammann said, “GM has realized about 200,000 additional auto sales in North America since it created GM Financial.”

This acquisition strategy seems sensible if you don’t know that Ally Financial was formerly General Motors Acceptance (GMAC) – GM’s former financing arm. Hence this is more of a re-acquisition. I wonder if this business unit will be divested in the future.

General Motors is also gaining access to a revolving line of credit with a $11 billion maximum balance. This new arrangement doubles the firms prior $5.5 billion five year credit facility which was scheduled to mature in 2015. General Motors’ website states how this move “offers improved pricing and terms, and the ability to borrow in currencies other than U.S. dollars.” Dan Ammann justified this financing by saying, “The new revolver provides a significant source of backup liquidity and financial flexibility, further bolstering our fortress balance sheet.”

This huge line of credit involved an army of different bankers. Thirty-five institutions from fourteen different nations participated in the deal. The financial retooling of this auto company must be a boon for investment bankers and lawyers. Unfortunately, these professionals are paid fees that come out of shareholder’s equity.

Conclusion

A cursory glance at financial ratios reveals that Honda, Toyota, and Ford are not compelling buys. Though General Motors has nice looking financial metrics, recent events at General Motors should give investors pause. They should realize that its price-to-earnings and debt-to-equity ratios are going to shoot up to unattractive levels.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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