Four years ago, anxious policymakers in Washington threw
automakers a badly-needed life line. The "cash for clunkers"
program, which bribed people into buying new cars, helped stave
off a death spiral that had beset the auto industry.
Yet just four years later, few people even think about "cash for
clunkers" anymore.Sales trends for the major automakers (and
their parts suppliers) are now booming, and it's easy to see how
trendswill get even stronger from here. Within a few years, sales
trends are likely to meet or exceed the previous annual peaks,
and share prices in this sector now have upward of 50%upside .
The Long Climb Back
In the middle of the past decade, the auto industry sold roughly
16 million to 17 million cars and trucks annually in North
America. That figure slumped to just 10.4 million in 2009 but had
rebounded to 14.4 million in 2012. Thisyear , that figure is
expected to be about 15.4 million.
Yet according toanalysts at Merrill Lynch, there are fourfactors
in place to suggest that this figure will hit 18 million in the
next five years. These factors include:
- Current sales levels are still below the replacement rate,
meaning the average age of cars on the road continues to climb
higher, recently hitting an industry record 10.6 years.
- Automakers are on the cusp of their most aggressive new
vehicle launch program in memory. "Thiswave of fresh product
will likely stimulate demand and get consumers into showrooms,
especially as automakers continue to pick up marketing
spending," noted Merrill's analysts.
have the most aggressive product cycle refresh plans in the
industry over the next three years, more than any major
Japanese, European or Korean automaker. And as Merrill's
analystsnote , "Replacement rates drivemarket share ."
- Financing rates should remain very low, as it will likely
be several years before the Federal Reserve hikes the rates
that determine autoloan rates. Moreover, dealers are noting
much easier access tocredit for most applicants than a few
- An eventual rebound in new home construction (which has its
own set of pent-up demand factors) should trigger a rising wave
of high-margin pickup truck sales. (Notably, pickup truck sales
rose roughly 25% in May for the three U.S. automakers, compared
with a year ago, and that spurt comes before any major upturn
in new home construction has begun.)
If the industry indeed sells 15.4 million units this year, the
move up to 18 million in five years represents growth of 15% to
20% from current levels, which may not seem like much. But
thefixed costs in the auto industry are so high that those
incremental sales carry far higher variable margins than
theprofit swing that automakers saw from 12.7 million units in
2011 to the current sales volumes.
Anotherfactor many overlook is sharply falling labor costs. The
average auto worker now makes around $55 to $60 an hour in wages
and benefits, down from $75 in 2007. Moreover, advancing
technology has increased assembly-line automation, which means
more autos are being made with fewer workers.
Lastly, industry capacity is now 15% lower than in 2007, which
means the industry will have solidpricing power as volumes rise
and won't have to resort to the hefty rebates that once bedeviled
The Profit Impact
Despite the emerging boom in the North Americanmarket , the
European market still stinks. Ford, GM and others are bleeding
That's why Ford, for instance, is seeing near-termearnings per
) forecasts stuck near $1.50 a share. If we were talking solely
about the North American market, and Ford were simply to retain
constant market share in a market that rises to 18 million units,
we would likely be talking aboutEPS in excess of $2.50 and
perhaps approaching $3.
Will Ford and others keep hemorrhaging cash in Europe? All the
major automakers are belatedly tackling their cost structure in
Europe, and break-even results could appear as soon as next year
or 2015. That should help investors focus again on the stunning
levels of profitability in the North American market.
Might the region eventually be a source of profits? Analysts at
Sterne Agee think European auto sales will bottom out this year
at 16.9 million units and rebound to 17.5 million units by 2015.
At that level, modest profits -- instead of open-ended losses --
may become the norm.
What Kind Of Upside?
Roughly six weeks ago, I looked at whether Ford or GM was the
I gave the slight edge to Ford (and itsshares have
subsequently risen close to 25%), yet also noted great appeal in
GM's shares and thatstock has risen about 20% (against a 5%gain
for the S&P 500).
Yet with a view toward 18 million vehicles sold annually by
2018, the upside remains robust. There is a wide variety of
metrics with which to value thesestocks , with many focusing
onearnings before interest,taxes ,depreciation andamortization
(EBITDA ) in the context ofenterprise value . In this instance, I
prefer a straight-ahead price-to-earnings (P/E ) ratio approach.
The prospects for $3 per share in profits for Ford within a few
years are taking shape, and if you assign amultiple of $8 to that
figure, you get to $24 (50% upside). GM is likely to earn around
$3.40 a share this year, but with a growing U.S. market and
shrinking losses in Europe, that figure looks set rise at a
Credit Suisseanalyst Chris Ceraso wrote that "by making
reasonable assumptions regarding regional sales, market share and
earnings before interest and taxes (EBIT ) margins, we see 2015
earnings in the $5 range as very achievable, with potential
upside toward $6 by 2016 should GM deliver on its
mid-decademargin targets."Assuming $5.50 in EPS by 2016 and
applying the same multiple gets us to $44 a share, which is
roughly 30% above current levels.
Risks to Consider:
Though the U.S. consumer appears increasingly confident, an
economic slowdown would derail the auto industry's recovery as
potential new car buyers grow skittish. Moreover, the bright
outlook for automakers is partially based on an upturn in new
home construction, which may or may not come to pass.
Action to Take -->
The charm of these auto stocks is that even after solidgains in
recent months, they have so much upside left simply because they
were so utterly cheap in 2012.
This same logic can be applied to the auto parts suppliers, many
of which also have much stronger balance sheets, much lower labor
costs, and are leveraged to yet higherprofit margins as industry
volumes rise. A few months ago, I noted that these firms were in
a position to be key players on the current mania for stock
buybacks, which could radically reduce their share counts and
pump up earnings per share.
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