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Ford and GM Just Answered a Big Question. But Does That Make the Stocks a Buy?

One of the biggest questions facing automakers in a few years was this: "Will new labor contracts cripple profits?" The negotiations between United Auto Workers (UAW) and major automakers can sometimes get bitter, and with the former aggressively going after the best contracts in recent memory, it was an ominous development for auto investors.

Fortunately, we may already have an answer to the previous question, and it appears to be good news for Ford Motor Company (NYSE: F) and General Motors (NYSE: GM) investors.

Big contracts, big costs

From the start of negotiations, the UAW made it clear it was going for an ambitious contract that would aim to be the largest amount of gains in wages seen in years. That goal was fairly well accomplished, and the price tag for the new contract hit automakers like Ford and General Motors hard.

In fact, Ford anticipates the new UAW contract to cost roughly $8.8 billion -- two times the initial expectation -- over the four-and-a-half-year deal. Ford's crosstown rival, GM, predicts its deal with UAW and Canadian union Unifor will cost up to $9.3 billion.

Those are big figures when you consider Ford's updated full-year guidance calls for adjusted earnings before interest and taxes (EBIT) in the range of $10 billion to $10.5 billion. Investors are already seeing real impact, as Ford lowered its guidance due to the new contracts from a previous range of $11 billion to $12 billion.

Let's put those figures into perhaps more understandable numbers for investors. Ford's new UAW contract will increase costs per vehicle by roughly $900. GM's number is actually lower because it employs roughly 10,000 fewer UAW members than its cross-town rival; GM expects its per-vehicle costs to increase as much as $575 on average throughout the life of the contract.

Question answered?

One of the biggest questions now facing major automakers is if they can offset these drastic cost increases. While investors should take these initial comments with a grain of salt -- we don't really expect management to fold and say they're going to go out of business -- both Ford and GM appear confident they can almost completely offset these wage increases.

GM management said it's preparing a 2024 budget that should offset much of the increases already. In fact, GM is working to cut $3 billion in fixed costs by the end of 2024.

Further, and grain of salt still in hand, it appears labor cost is less significant than it was in the past. "Labor cost is not as significant from an overall cost perspective as it was in the past," Michael Ward, equity research analyst at Benchmark, told Automotive News. "GM and Ford should be able to offset most of the increase in labor costs with other improvements."

To be fair, if GM management is puffing out its chest to show confidence, it's at least putting its money where its mouth is. GM announced it would buy back $10 billion in shares while also increasing its dividend 33%. If management can confidently announce that right after contract negotiations, they're doing everything they can to appear at ease as they work their 2024 budget to mostly offset the new contracts.

Are the stocks a buy?

Investing in cyclical industries, especially the automotive industry, which is notoriously capital intensive, isn't for everyone. However, for value investors, or perhaps income investors, there's a compelling case for both Ford and General Motors right now. Ford and GM trade at a cheap price-to-earnings ratio of 7 and 4.7 times earnings, respectively, and have declined 16% and 12%, respectively, compared to the market's 17% gain over the past year.

On top of being cheap, Ford also offers income investors a juicy 5.4% dividend yield. While GM's yield is much lower, management's recent decision to boost the dividend 33% with a $10 billion share buyback plan shows willingness to return value to shareholders.

If management of both automakers prove they can execute and offset much of the new labor costs, this could be a great entry point into the two Detroit auto stocks before they bounce back.

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Daniel Miller has positions in Ford Motor Company and General Motors. The Motley Fool recommends General Motors and recommends the following options: long January 2025 $25 calls on General Motors. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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