Ford & GM Are Still...

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

Anybody who hasn't been living under a rock could tell you that there has been substantial tectonic shifts in the domestic auto market. From the auto bailout to their current rise to product recalls today, the market has been up and down on the industry. However, value investors look at the long-term trends of companies and where they can go in terms of capturing market share. If the free cash flow generation is already strong, and certainly strong enough to support robust research and development, the upside is probably strong and at a bargain in light of the uncertainty in the near macro environment. Below, I review 2 US auto producers and present several reasons why you should invest in them.

Don't Give Up On Ford (NYSE: F)

Over the last 6 months, investors have started to make somewhat of market correction at Ford with the stock up 15.5%. However, shares are still significantly undervalued to the point of being ridiculous. At only 8.1x forward earnings and substantial free cash flow generation, Ford is poised for a meaningful comeback. The $44.4 billion company generated $4.4 billion in free cash flow the TTM ending 3Q12, or a yield of 10%. And with the territorial disputes going on between Japan and China, you can expect a tailwind coming in from a decline in Toyota sales. It should not be surprising then that Ford sold a record number of vehicles in China during November, 67,505, which is up 56% y-o-y off of momentum for the Ford Focus.

There are several other reasons to be optimistic about the iconic auto producer. Despite the overblown concern over product recalls, sales have not been harmed by the negative news flow. The C-MAX hybrid, for example, posted 8,030 sales in just the first two months following launch, and this line outsold the Toyota Camry hybrid. Notably, the number one trade in for the C-MAX was the Toytota Prius, so the company is showcasing a bit of a competitive edge. The $135 million planned reinvestment in 5 new electric vehicles-- it has around a 11% share--that will be marketed by year's end further add to the growth story. And then there's the obviously lowered manufacturing costs resulting from a shift towards right-to-work laws--Michigan being the 24th state to pass this pro-management piece of legislation.

GM (NYSE: GM) Also Attractive

There are several reasons why you should invest in GM over its domestic competitor. It has a more favorable opinion on the Street with 12 of 15 reporting analysts rating the stock a "buy" or better, an the rest saying "hold." Second, return on invested capital ("ROIC") is solid at 18.9%, which is 1,200 bps greater than the industry average. ROIC is the source of all value creation when it is above the average cost of capital. It should not be surprising that Billionaire value investors Warren Buffett and David Einhorn have stakes in the auto producer. Third, the company is suffering from as much negative news flow and has less negative short-term catalysts under a largely uncertain short-term macro environment.

The company's stability and lack of short-term negative catalysts are the result of a strong balance sheet. More than 75% of the company's value is backed by cash, which comes out to $41.6 billion. This is more than enough for the company to navigate cost headwinds through taking advantage of a low interest rate environment to invest in R&D. The PEG ratio stands at 0.9x, so if GM can deliver on its sharp growth curve, substantial value creation will follow. As it stands, the company is worth only 5.3x its 2016 projected EPS. Assuming expectations are met, the company would be worth just north of $67 at a 13x multiple, or $41.65 at a 10% discount rate. This would provide an average annual return of 10.5% assuming that the market just corrects for the market price anomaly!

GM is also strong operationally. It will be raising prices in India by as much as 3% to offset rising input costs and FX headwinds. The company has a Chinese research center that is likely going to research electric cars and hybrids. According to consulting firm McKinsey, auto sales in China are expected to rise 8% on average each year to 22 million by 2020, and the main interest will be in larger vehicles. GM has been on the forefront of this growing demand through focusing on new truck models. For these reasons, I encourage buying shares in GM.


TakeoverAnalyst 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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