Bad Times For Automakers?

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

Given weakness in the European car market, leverage in automakers, and monetary instability in Japan, I think investors should not overweight automakers. Auto stocks are either not cheap enough to justify a long position or are overleveraged.

French Auto Workforce Reductions

Renault announced a decline in its European sales during 2012, and will reduce 17% of its workforce in the next four years to reduce its costs. It plans to eliminate 7,500 job positions by 2016 in France, with 5,700 posts being reduced through attrition. All these measures will be undertaken to reduce the fixed costs by $528 million.

This strategy is sensible given reduced sales. According to Dominique Chauvin, Head of the CFE-CGC union at the company, production in France fell 18% in 2012 to 530,000 cars.

Competitors Peugeot Citroen, Ford (NYSE: F), and General Motors (NYSE: GM) are also reducing workforces and closing down their plants in response to reduction in demand. Peugeot has decided to reduce 17% of its workforce in France and shut down a factory on the outskirts of Paris. General Motors is also closing down a plant in Germany, whereby 3,100 job positions are put at a stake. Ford Motor has also halted its operations at three factories, eliminating 5,700 positions.

According to Gerard Leclercq, Head of Renault’s French Operations, “If an agreement is signed with unions, this staff redeployment would need neither a plant closing nor any forced departures.”

Slumping European Auto demand

The proposed French downsizing is part of a larger trend of declining demand in Europe. The slumping European auto demand, which has continued for six years straight, has Peugeot Citroen worried about its cash hoard. Peugeot is estimated to run through about 1.7 billion Euros ($2.2 billion) of its 8 billion Euro ($10.7 billion) reserves in 2013, as the burn rate may lead the carmaker closer to liquidity problems brought by shrinking market share.

Since it caters mainly to the European market, Peugeot has been hardest hit as the region’s car market is seen to decrease to 12.3 million units, 23% below the pre-crisis high. The carmaker’s share price is forecast to drop to 11.8% from 12.8% in 2007, according to IHS Automotive.

Peugeot, Europe’s second-largest carmaker, sold 17% fewer vehicles last year, with the worst drop in the fourth quarter. Attempts at exports with low-cost models like the Peugeot 308 sedan failed to insulate it from what Fiat CEO Sergio Marchionne called Europe’s “Carmageddon.” The renewed drop in European sales may fall 4% to 1.5 million cars this year, and strain finances further.

Standard & Poor’s estimates Peugeot’s 2012 spending at 6 billion euros ($8.0 billion) and with liquidity, including credit lines, standing at around 10 billion euros ($13.1 billion), and the latter has about 2 billion euros ($2.7 billion) before cash declines below the former’s threshold for adequate liquidity. S&P computes adequate liquidity as having 120% of the funds needed for expected spending, debt payments and planned outlay for factories and vehicle development for the year.

Peugeot’s long-term debt is rated BB, two steps below investment grade, with a negative outlook. Moody’s Investors Service and Fitch Ratings have even lower ratings at three levels below investment grade with a negative outlook. Moody’s rates Peugeot’s banking unit, (Banque PSA Finance) BPF, one step above junk. If BPF’s rating drop to non-investment grade, borrowing costs for Peugeot’s buyers will increase, making the company less competitive.

To raise funds, Peugeot had been selling assets last year, including its headquarters building, its 7% stake to General Motors, and a majority stake in Gefco, its trucking unit. The company plans to shut down a factory near Paris and cutting around 550 million euros ($732 billion) in spending. Commerzbank analyst Sascha Gommel said, “Going bankrupt is not an option. The French government will do something in the end.”

The French government agreed to guarantee 7 billion euro ($9.3 billion) in BPF’s new bonds, and helped finalize agreements for a 11.5 billion euro ($15.3 billion) refinancing package from a pool of about 20 banks, spokesman Jean-Baptiste Mounier reported. As part of the guarantee deal, the French government took a seat on the company’s supervisory board.

Peugeot hopes to sell more cars globally this year. It will also try to win back consumers lost to Volkswagen and Hyundai Motor when sales slide by 18%, even worse lower than the industry’s dreadful 14% decline. Volkswagen slipped 5%, while Hyundai’s sales surged 28%. Peugeot plans to rationalize its French automotive operations by cutting 11,200 positions, or 17% over the next two years in order to raise utilization rates at its European factories to a profitable level. These measures may not be enough. Commerzbank’s Gommel said, “At the moment, it’s difficult to have a perspective for the business model. There’s no example in the past where a mass carmaker was successful by reducing its capacity.”

Hyundai, Kia Forecast Slowest Growth in Seven Years

Other carmakers are cautioning investors about the weak global economy. South Korean carmaker Hyundai predicted its lowest sales in seven years as a result of global economic downturn and strengthening currency saps demand.

Chung Mong Koo, the chairman of Kia and Hyundai, told employees to be ready for the difficult year ahead and also be flexible to changes of this market. The two companies are facing a major hurdle with its currency, the won, which has appreciated more relative to other Asian currencies in the second half of 2012. NH Investments & Securities analyst Lee Sang Hyun said, “The automobile industry is relatively more currency sensitive, as fierce competition leads to competitive pricing.”

Valuations

Consider their financial metrics:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>P/FCF</span></strong></p> </td> <td> <p><strong><span>D/E</span></strong></p> </td> </tr> <tr> <td> <p><span>F</span></p> </td> <td> <p><span>Ford</span></p> </td> <td> <p><span>3.19</span></p> </td> <td> <p><span>0.4</span></p> </td> <td> <p><span>2.87</span></p> </td> <td> <p><span>13.51</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>11.01</span></p> </td> <td> <p><span>0.3</span></p> </td> <td> <p><span>1.1</span></p> </td> <td> <p><span>43.67</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>18.5</span></p> </td> <td> <p><span>0.68</span></p> </td> <td> <p><span>1.39</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>18.02</span></p> </td> <td> <p><span>0.69</span></p> </td> <td> <p><span>1.25</span></p> </td> <td> <p><span>40.72</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. They are also recovering from Chinese boycotts against Japanese companies. Disciplined investors have to wait for these valuations to drop.

Ford is so highly levered that it is more like a financial services company that finances auto loans than a carmaker. General Motors isn’t much better since the firm is taking steps to become more leveraged and is having problems in its supply chain which threatens end-of-year and 2013 profits.

Investors should remember that General Motors went bankrupt in the financial crisis and this justifies caution because firms which emerge from bankruptcy often have lingering financial problems. Past financial distress often foreshadows future financial stability.

Worse yet, General Motors is gaining access to a $11 billion revolving line of credit, doubling 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.”

Conclusion

The macro picture is not compelling for car sales. What’s worse, Ford is highly leveraged and General Motors is levering up. Across the Pacific, Japanese automakers are not trading at compelling valuations and are at the mercy of currency changes. There is no reason for investors to initiate positions among these companies at this time.


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