Are These 4 Auto Giants Compelling Buys?

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

Given the current outlook, I think investors should not go overweight automakers. Most of these companies are either not cheap enough to justify a long position or are overleveraged.

Hyundai, Kia Forecast Slowest Growth in Seven Years

Many carmakers are cautioning investors about the weak global economy. South Korea’s two main car brands, Hyundai (NASDAQOTH: HYMLP) and its smaller associate Kia, have predicted their lowest sales in seven years as a result of global economic downturn and the strengthening Korea won sapping demand.

According to Chung Mong Koo, the chairman of both companies, the two giant car makers will generate a combined sales increase of 4 percent, translating to 7.4 million cars this year. He told employees to be ready for the difficult year ahead and also be flexible to changes of this dynamic market. The two companies are also facing a major hurdle with its currency, the won, which has appreciated more relative to other Asian currencies over the last six months. The volatility of the currency has been a hindrance in competing globally against other major car manufactures like Toyota (NYSE: TM) and General Motors (NYSE: GM).

Lee Sang Hyun, an analyst at NH Investments & Securities said, “The automobile industry is relatively more currency sensitive, as fierce competition leads to competitive pricing.”

Recent reports indicate that the two car manufacturers had exceeded their 2012 sales target of 7 million units by 120,000 units. However, sales projections for this year are slightly lower than what was generated last year. Chung Mong Koo, the chairman said, “2013 will be a very difficult year as the ongoing European crisis and the slowing global economy affects international and domestic markets.”
Hyundai anticipates that its sales will rise to 5 million vehicles this year which is 60,000 units more compared to what analyst had estimated while Kia estimates are sales will increase to 3 million units which is lower than what was estimated. Both companies heavily rely on international markets for their car products; Hyundai’s largest market is China while Kia largely depends on the U.S market.

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>P/FCF</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>3.07</span></p> </td> <td> <p><span>0.38</span></p> </td> <td> <p><span>2.76</span></p> </td> <td> <p><span>13</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>11.23</span></p> </td> <td> <p><span>0.31</span></p> </td> <td> <p><span>1.12</span></p> </td> <td> <p><span>44.53</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>17.56</span></p> </td> <td> <p><span>0.65</span></p> </td> <td> <p><span>1.3</span></p> </td> <td> <p><span>NA</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>17.67</span></p> </td> <td> <p><span>0.67</span></p> </td> <td> <p><span>1.21</span></p> </td> <td> <p><span>39.87</span></p> </td> <td> <p><span>1.09</span></p> </td> </tr> </tbody> </table>

Honda (NYSE: HMC) and Toyota trade at earnings multiples above the market average. Honda and Toyota are also recovering from Chinese boycotts and riots against Japanese companies. If they had amazing growth opportunities, then these earnings multiples could be justified. Unfortunately, they do not. Therefore, disciplined investors have to wait for these valuations to drop.

Ford (NYSE: F) is so highly levered that it is more like a financial services company that finances auto loans than a manufacturer.

General Motors is taking steps to become more leveraged and is having problems in its supply chain that threatens end-of-year and 2013 profits.

GM Production Line Problems

General Motors’ recent supply chain issues could lower its earnings and lead to a higher P/E ratio. Currently, the company’s focus is to clear that inventory to make room for crucial new models, even by cutting prices. The most recent models of the GMC Sierras and Chevrolet Silverado and set to be launched in 2013, and may not have room because of high inventories in other models. The new models, especially big trucks, are a cornerstone of the company’s strategy in 2013. Big pickups contributed about 23% of its U.S. sales over the last year.

Baum & Associates 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 the new trucks. 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.

Much of the high inventory was a part of General Motors’ 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. 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.

General Motors is Gearing Up

Investors should be concerned by how General Motors is borrowing and acquiring more financial operations. They should remember that General Motors went bankrupt in the financial crisis and that firms which emerge from bankruptcy often have lingering financial problems. Past financial distress is a bad indicator of future financial stability, and these concerns are not alleviated by more debt financing or the acquisition of financial firms.

Investors should be concerned by how General Motors is gaining access to a $11 billion revolving line of credit. This new arrangement doubles the firms prior $5.5 billion five year credit facility. 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.”

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.  This acquisition strategy could seem sensible if you didn’t know that Ally Financial was formerly General Motors Acceptance (GMAC) – GM’s former financing arm. From a long-term perspective, this is more of a re-acquisition. Is this a cyclical phenomenon? If so, this business unit could be divested in the future.

Conclusion

Financial ratios reveal that Honda, Toyota, and Ford are not compelling buys. Though General Motors has nice looking financial metrics, changes at General Motors should inspire investors to stay away. They should realize that its price-to-earnings and debt-to-equity ratios are probably going to jump up to unattractive levels.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors Company. The Motley Fool owns shares of Ford. 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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