Why Ford, GM Are Great Buying Opportunities

By David Gould - September 16, 2012 | Tickers: F, GM, TM | 0 Comments

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At this point, whenever you hear the names "Ford" (NYSE: F) or "General Motors" (NYSE: GM) brought up, it is almost always in political dialogue and seldom in financial dialogue. Okay, maybe you hear about Ford and GM occasionally on CNBC, but what's strange is that no one really wants to talk about their value… the essence of their fundamentals. It is as if saying something puts you in danger territory. Well, fortunately for readers, I am willing to put myself in danger territory.

I think both Ford and GM are substantially undervalued - especially when you compare them against japanese producer Toyota (NYSE: TM). From low multiples to impressive balance sheets, the future looks bright under the context of a full recovery.

Ford trades at a bargain price of 7.1x forward earnings with a PEG ratio of 0.32, which indicates that future growth has been nowhere close to being fully factored into the stock price. The company has a strong brand name that will generate sales regardless of how badly it was hit during the recession. That only 7.5% annual EPS growth over the next 5 years would be forecasted sets the bar low for higher risk-adjusted returns.

Moreover, Ford itself is showcasing signs that are in marked contrast to the attitude of the Street. It is like Ford is trying to subtly show investors its values without looking obvious or desperate. The 1.9% dividend yield illustrates confidence over free cash flow, which already merit a higher valuation. While FCF of $5 billion over the TTM ending 2Q12 was low compared to $7.2 billion in 2Q11, it still comes at a 12.5% yield to the market capitalization!

At the same time, the auto producer is taking active steps to grow margins. By lowering the consumption of rare earths used in the manufacturing of cars, Ford will be able to save hundreds on each unit. Moreover, the company is being aggressive against labor, which will help prevent costs from rising during a recovery. For example, they refused to guarantee Belgium workers concessions over a plant closure. In addition, the company is restructuring operations and indeed looking to close an aging factory, which will help drive greater return on invested capital.

GM has similarly attractive fundamentals, but it stands out for its impressive balance sheet. With $32.6 billion in cash (86% of market capitalization), the company has a ton of liquidity to play with and grow scale. Critics may discount this by saying that it is money from the US government, but it cash is still cash. 

And, thus far, GM has effectively used the cash. FCF for the TTM ending 2Q12 was $1.1 billion versus $703 million in 2Q11. Despite this impressive growth, shareholder value did not go up high enough - only 12% over the last 12 months. The stock continues to trade at low multiples of 8.6x and 6.1x past and forward earnings, respectively, despite showing excellent fundamentals and an ability to recover from its knees.

On the longer-term, however, I recommend Ford over GM. The fact that it was able to survive the recession and auto collapse by itself was evidence of better fundamentals. It also makes the firm less of a regulatory target. Moreover, if current events hold consistent, GM will struggle in the growing electric and hybrid market. Reuters recently reported it was losing $49K on each Chevrolet Volt built, for example.

To get a sense of how undervalued GM and Ford is, take a look at Toyota. The Japanese auto producer trades at 17.9x past earnings and is rated a "hold" on the Street. It may struggle to return to a leading market position despite having one of the strongest financial positions. Manufacturing issues and recalls have tarnished the brand image and will prevent the company from fully maximizing free cash flow during a recovery. Accordingly, I recommend holding out and buying GM and Ford instead.

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