Hot Wheels or Lemons?

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

Americans love their cars.  Given the lingering effects of the Great Recession and fresh memories of the General Motors (NYSE: GM) bailout, does it make sense to invest in automobile manufacturers today?  If so, which company is worth the investment risk?  According to R.L. Polk marketing research, Americans are holding on to their cars longer rather than buy a new one.  Reasons vary; some say the high unemployment rate is dampening demand, others say a new car is grossly overpriced, others point to a trend of longer car loan terms.  Is this aging of the American car a sign of pent up demand that will drive car sales in the future or an ominous trend of lower sales as Americans hunker down in an age of economic uncertainty?  Time will tell.  Does any car maker have an advantage to make it worth the risk in these tough times?

Of the US auto makers, Ford (NYSE: F) has customer loyalty going for it.  For two years in a row, Ford has ranked #1 in overall customer loyalty, also according to Polk. After jettisoning its Jaguar, Aston Martin and other foreign car makers, Ford has rolled out several new models of cars and trucks with positive reviews.  For the end of calendar year 2011, net income was significantly higher than 2010, but this was largely due to differences in income tax expense.  They have reported declining sales in Europe but improved sales in Canada, China and Eastern Europe/Russia.  Shares are trading at almost ridiculously low earnings multiples.  Ford is hanging on, if they can keep improving car quality and market share, the company could prove a value play rather than a value trap.

GM, on the other hand, has problems.  Its government bail-out, particularly the favorable terms for the UAW at the expense of bondholders, has alienated some potential customers.  Its market share is declining and its Opel division is a constant source of losses.  Net income, revenue and free cash flow from auto operations are all declining.  As Joann Mueller of Forbes wrote, "this is not a company headed in the right direction."  Indeed.  While I won't jump on the "GM is going bankrupt" bandwagon, I won't be a shareholder anytime soon.

One company that is going in the right direction is Volkswagen (NASDAQOTH: VLKAY). CEO Martin Winterkorn is working to make VW the world's biggest and most profitable car maker in the world.  So far, so good.  VW has steadily increased market share and income has followed suit.  Notably, VW reported record profits in 2011.  Dr. Winterkorn is proving to be a stickler for quality.  The guy reportedly  carries a micrometer in his pocket while touring manufacturing plants to check on space between body panels.  They face the usual challenge of a worldwide slumping economy.  As owners of brands as diverse as Skoda to Lamborghini and Bentley, Volkswagen also has the challenge of streamlining its production to maximize efficiency while leaving each brand flexibility to develop their own cars and style.  Somehow, I think they're going to pull it off.

And speaking of German automobiles, I must mention Daimler AG, better known in the US as Mercedes Benz.  Years ago, when my parents were buying their first house, their realtor told them to buy in the best neighborhood possible.  "People with money will always have money; those who don't, won't" the realtor said.   A shrewd observation.  People with money tend to buy luxury cars and Mercedes is a popular choice.  While the overall demand for Mercedes is under pressure, most notably in western Europe and China, Daimler is sticking to its forecast that its profits will be on par with those of 2011.  Reuters reports however, that some analysts believe Daimler isn't as good at making forecasts as it is at making cars.  Daimler acknowledges it is losing market share to Audi and BMW, particularly in China, but plans to unveil revamped sports cars to take on its rivals.  Results reported for Q2 2012 show record unit sales for Mercedes cars and improved sales in most other vehicle divisions. Daimler also pays a dividend of 5.5% or so, significantly more than VW's dividend of about 2.4%.

So what to do?  I'd go with VW for growth prospects and Daimler for combined income and growth.  VW has momentum, Daimler has the Mercedes brand and a nice dividend.  Ford is OK, but given the US economy and the tough sledding the American middle class is experiencing, I'm not optimistic for strong sales or profit growth at Ford.  GM, well, I might sell short.  I have no confidence in them at this time.


dylan588 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.If you have questions about this post or the Fool’s blog network, click here for information.

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