Which One Is Better: Ford or GM?

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

As of late, the debate for Ford (NYSE: F) and General Motors (NYSE: GM) has centered around the potential for additional profitability in North America, as well as the opportunity to staunch losses in Europe given an improved view by some that the market is improving.

Although Ford is expected to benefit off the Europe rebound in the near term, Barclays prefers GM over the long term, maintaining a contrarian view vs. those who believe that Ford’s North American margins will run higher amidst improvements in the region.

The question that investors ask is which one is better--Ford or GM?

Near-term scenario

In the near term, the potential is there for both original equipment manufacturers (OEMs) to benefit from the Europe rebound, with Ford likely to get the edge if pricing improves. Given renewed enthusiasm by some investors around the notion that structural problems in Europe have dissipated, there is increased likelihood that both Ford and GM will experience a bull trade.

The near-term production risk for the OEMs has declined, with risk shifting to the suppliers over the mid/long-term. Moreover, as OEMs begin to feel more comfortable with Europe (especially as the reduction in austerity programs help to lift sales in France, Italy, and Spain), it is less likely that the OEMs will aggressively discount models in Europe, which could potentially lead to 2Q and 3Q beats by Ford and GM in Europe.

Second- and third-quarter beats by Ford and GM in their European units could be near-term catalysts for the stocks. Moreover, the Europe trade could benefit Ford over GM for several reasons:

a.) Europe accounts for a larger portion of Ford revenue than GM (18% for Ford, 12% for GM)

b.) Ford posted a greater disappointment in Europe in 1Q than GM (loss of $462 million for Ford, loss of only $175 million for GM), creating a better opportunity for rebound

c.) Finally, given Ford’s membership in the S&P 500, portfolio managers may want to own Ford for exposure to the strengthening U.S. consumer, especially if they see Europe risk as dissipated. However, this point might have become invalid after June 6, when GM rejoined S&P 500.

Long term – Is GM better than Ford?

However, as a Motley Fool blogger, it is the long-term scenario that matters more. Over the long term, there is a better opportunity for upside in GM’s stock than Ford. There are three reasons backing this opinion:

1. Yes, Ford remains the better company, but GM is improving much more quickly than people think. In particular, during recent meetings with management at GM, analysts at Barclays were struck by several developments, including the elevated visibility and influence of engineering within GM, progress on global platforms and modularity, and the increased understanding for the need of brand accountability. GM also appears to be making progress on improving operations and financial controls.

2. North American margins clearly tell the story of where upside lies. For Ford, current North American pre-tax margins are in the 10% to 11% range, and are likely “as good as it gets,” especially as Ford would rather reinvest in product and brand initiatives than let margins run higher into the 12%+ range. GM, however, has upside to 10% margins in North America, up from the 7% posted in 2012. Improvements will come from product launches and cost reduction initiatives, and both sets of initiatives will bear fruits.

3. Moreover, the preference for GM is not simply relative to Ford, but also stands as one of the top picks in this space. Simply put, investors under-appreciate the turnaround at GM, as evidenced in GM’s valuation. While other suppliers like Dana (NYSE: DAN) and Lear appeared “cheap” last year, they no longer appear “cheap.” Meanwhile, GM’s valuation has not improved in the same manner. It is currently at 2.3 2013 earnings EV/EBITDA, and one can easily see an additional turn of upside.

How are GM and Dana related?

For those who don’t know or just don't remember, it was Steven Girsky, the current Chairman of GM’s European operations, who brought around the turnaround at Dana a couple of years back. Since then, the market has favorably viewed Dana as an investment. Still Dana remains the most under-appreciated “return of cash” story within the auto-supplier group.

Although return of cash to shareholders (particularly via execution of buybacks) has been very measured by management, at times to the frustration of some shareholders, positive comments were heard on the 1Q 2013 call that capital allocation is a priority for management and the board, and evaluation of boosting the size and pace of the buyback is a possibility. In short, investors are urged to be patient – the return of cash will eventually occur.

Final word

In the long run, GM seems to be the better investment given its upcoming catalysts, improving margins, a super management team to lead a European restructuring and cheap valuations. 

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Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. 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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