It May Be Time for Ford and GM

By Meena Krishnamsetty - March 21, 2013 | Tickers: F, GM, HMC, TTM, TM | 0 Comments

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Many value investors have been insisting for some time that US auto-makers Ford (NYSE: F) and General Motors (NYSE: GM) are attractive stocks. GM, in fact, was one of the five most popular stocks among hedge funds in the fourth quarter of 2012.

Billionaire David Einhorn of Greenlight Capital made his case for GM (though his take could also apply to Ford and the auto industry more generally) at October’s Value Investing Congress: Europe should regain profitability in the next few years, there are significant opportunities in China, and U.S. consumers will soon have to buy new cars as their current auto fleet is nearing record longevity. GM was one of Greenlight’s largest holdings by market value at the end of December. Appaloosa Management, managed by David Tepper, included both Ford and GM among its top ten picks.

February U.S. auto sales growth was down from January--in particular, car sales were flat--but the market in the first two months of 2013 still showed a strong improvement from a year earlier, and even in February Ford and GM produced growth in the mid- to high-single digits (GM was held back by a fall in car sales). The market share of each company is up in the last year. Of course, this has come as bad news continues to trickle out of Europe: it’s unclear what effect the Cyprus crisis will have on the macro situation, but certainly we are much less convinced on either the Europe or China legs of Einhorn’s thesis.

Revenue was about flat at both companies last year compared to 2011, and net income declined significantly. Ford generated 65% of revenues from North America and 21% from Europe; GM got 63% of its business from North America and 14% from Europe. In both cases European sales numbers have generally been declining in the last couple years, while revenue has been up in North America.

Both Ford and GM currently trade at 9 to 10 times their trailing earnings, so the companies could prove undervalued even if they maintain their business at current levels. If they can turn in moderate growth in developing markets and low growth in the U.S. then they would be in position to improve earnings as long as Europe does not continue to deteriorate.

But, as we’ve mentioned, that actually seems somewhat speculative at this point. Looking at analyst expectations, GM in particular is expected to see high earnings growth over the next several years, resulting in a forward P/E of 6 and a five-year PEG ratio of 0.5. Ford is making more of a case to income investors at a current dividend yield of 3%. Both are sensitive to the broader economy, of course, with betas in the 1.6 to 1.7 range.

Toyota (NYSE: TM), Honda (NYSE: HMC), and India-based Tata Motors Limited (NYSE: TTM) are three alternatives in the auto industry. Tata actually trades at a discount to Ford and GM on a trailing basis, but its financials are expected to come down over the next couple years; as a result it joins Toyota and Honda, which have trailing earnings multiples in the teens, in a range of forward P/Es between 13 and 15.

Certainly Toyota and Honda are more reliable companies (though their recent U.S. sales figures have not been as rosy). Analyst expectations peg each stock’s five-year PEG ratio well below 1, and in absolute terms they may be attractive value stocks, but it is certainly possible that they don’t merit this much of a premium.

We’re skeptical of the value thesis for Ford and GM, but the market is currently setting the bar very low--and certainly much lower than it is for Toyota and Honda. As a result even though we would guess that those two companies will perform better over the next couple years we would suggest that investors consider the two U.S. auto-makers on a value basis.

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