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U.S. automakers to feel
pinch of higher rates,
gasoline prices
NEW YORK » Lower sales, higher fuel costs and rising interest rates have helped make U.S. auto stocks some of the most unloved investments on Wall Street.
Just 30 percent of analysts rate Ford Motor Co. as a buy, and only 25 percent think you should take a chance on General Motors Corp., according to Zacks Investment Research. Most professional investors believe there are rough years ahead for Detroit, as huge fixed expenses, a protracted price war and an addiction to buying incentives cut into profits on each car sold.
When interest rates were at 45-year lows, automakers were able to boost sales volume to record levels by offering great deals with sweet financing terms. They also focused on more expensive products, such as sport utility vehicles, light trucks and minivans. Now that interest rates are rising and higher gas prices have made consumers more mindful of fuel economy -- softening demand for larger cars -- that strategy seems unsustainable.
"The fundamentals of the auto industry for every manufacturer are bad. It's a bad business to be in," said Phil Guziec, an equity analyst with Morningstar Inc. "So many new vehicles have been stuffed out there, they've stuffed their pipeline. Eventually that's going to come back to haunt them. And the worst part is, the whole time they've been selling more cars, they haven't been making that much money on them."
Annual sales rates for cars, trucks and SUVs sold in the United States have hovered between 15 million and 16 million since the mid-1980s. For the past two and a half years, the average annual sales rate has been 16.7 million. But last month the seasonally adjusted annual sales rate dipped to 15.4 million units, delivering a punishing blow to auto stocks.
"They had a great run. The question is now what?" said Kenneth McCarthy, chief economist with vFinance Investments Inc. "It's so unusual to look back and say auto sales rose during the recession, that's never happened before. But the economic reality is that at some point they have to cycle down."
Hastening that slowdown is the rise in interest rates. Low rates helped sustain auto sales over the last three years, as minuscule borrowing costs lured consumers and mortgage refinancing gave them greater buying power. Now that's coming to an end: The Federal Reserve ordered the first of what most believe will be a series of rate hikes this past week.
Another factor working against domestic auto makers is rising fuel prices, and their dependence on sales of SUVs and minivans. Foreign manufacturers are accustomed to dealing with high gas prices in their domestic markets, so they may have an easier time adapting their product mix in the United States. They've already started to take a higher market share this year, edging closer to the levels they enjoyed in the late 1980s.
Despite the strikes against them, some market contrarians believe the big U.S. car makers are worth holding on to. They're attractively valued by price to earnings ratio -- market capitalization divided by after-tax earnings -- and are known for paying substantial dividends.
GM, for example, has a forward-looking P/E ratio of 5, and pays a 4.4 percent yield. In contrast, the Standard & Poor's 500 has a P/E somewhere between 17 and 20, depending on how it's measured, and a yield of about 1.5 percent.
Additionally, notes Bernie Schaeffer, chairman of Schaeffer's Investment Research, the concerns about interest rates and consumer spending that make so many market watchers bearish on auto stocks could be just as easily applied to other industries, such as homebuilders and retailers.
"There's downside risk to GM, just like there's downside risk to the economy, but I don't think it's greater than it is with other stocks that Wall Street is much more enamored with," Schaeffer said.
Turning an old Wall Street axiom on its head, Schaeffer said, "What's bad for GM is bad for the economy ... if these fears turn out to be realized, there's not a whole lot of places to go." For this reason, he thinks it's prudent to keep a hefty chunk of your holdings -- perhaps 25 percent -- in cash, and to shop carefully for stocks, including those that are out of favor.
"It might sound scary, only 25 percent of analysts have 'buys' on GM, but there's also an upside to that," Schaeffer said. "If the economy surprises us on the plus side, you have a lot of potential for analyst upgrades."
Not everyone agrees GM is fairly valued, however. Morningstar, which gauges value by free cash flow rather than price multiples, considers all the auto stocks overvalued -- including foreign car makers.
Although auto stocks appear to be sagging, most are far off their bottoms. Ford, which now trades at about $15 per share, was selling for less than $7 in March of 2003. Guziec, the Morningstar analysts, thinks there are better places for investors to put their money.
"I couldn't tell you when to sell, but I can say they're not great companies to own," Guziec said. "If you want to buy a not-great company cheap, you want to make sure you buy it really cheap, and the people who did that were the ones who bought Ford in early 2003."
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