Revving Up: Can Auto Stocks Find a Higher Gear?
The city of Detroit may be a financial mess, but its automakers — Ford and General Motors — are in the best shape they've been in years, according to analysts. And U.S. March auto sales, due out on Tuesday, by many estimates should be strong.
The stocks, however, are a different story.
"You have very strong underlying demand fundamentals," Sterne Agee auto analyst Michael Ward told CNBC.
Morningstar analyst David Whiston agrees, saying " I think people don't give Detroit enough credit for how much healthier they are."
Both analysts said the companies have done a good job of reining in costs and increasing car prices. "The industry itself, for the first time ever, you're seeing pricing being positive and costs going down," Sterne Agee's Ward said. "And that is setting up a good value opportunity for the stocks."
But that value play—along with pent-up consumer demand and corporate restructuring in Detroit—comes with risks including economic overhangs in Europe.
A Higher Gear in the US
Americans delayed auto purchases during the recession. Plus, as consumers drive cars for an average 11.2 years, it was time to buy again for many — spiking demand and fueling growth in the U.S. auto market. A lack of used cars is also pushing up used car prices, making new vehicle purchase more attractive. And with interest rates low, financing remains cheap.
"This industry is pretty simple. It's driven by interest rates and it's driven by consumer confidence. Interest rates are at historic allows, consumer confidence is improving, and when you lay on top of that the average car on the road is over 11 years old, there's a lot of pent-up demand," Jim Lentz, Toyota USA president, told CNBC.
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March auto sales, due out on Tuesday, should be strong, JD Power and LMC Automotive predict. They are forecasting total light-vehicle sales of 1.465 million units, an 8 percent increase from March 2012.
March new-vehicle retail sales are expected to come in at 1.158 million vehicles, which represent a seasonally adjusted annualized rate (SAAR) of 12.1 million units, with volume approaching a double-digit increase from March 2012. "Retail transactions are the most accurate measurement of true underlying consumer demand for new vehicles," JD Power and LMC wrote in a press release.
New auto models should fuel demand further as the year goes on. Automakers should introduce 41 all-new vehicle models in 2013, a 78 percent increase from the 23 launched in 2012, according to Tom Libby, lead analyst for North America automotive market intelligence firm Polk. Redesigns, meanwhile, will more than double to 60 from 29 last year, he said.
Many of these new models will come from Detroit. "During 2013, there tends to be a skew toward General Motors," Libby said of the expected new models. "That's primarily because they had a lack of new product launches during their restructuring."
And with automakers spending heavily to market new models, it tends to drive showroom traffic, which often translates into new sales. While GM will account for the bulk of the new models this year, eventually all the major automakers will be refreshing their product lineups given the stiff competition, Libby said.
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Automakers are also shifting their focus to new smaller models as they drive to meet new fuel efficiency standards. By 2016, the average fuel economy for cars must improve from today's 27.5 mpg to 37.8 mpg.
Consumers are also looking for better fuel economy given high gasoline prices, and peak summer driving season just around the corner. Regular gasoline prices remain well above $3 per gallon, according to the AAA's Fuel Gauge Report.
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For 2013, both JD Power and Polk are projecting total vehicle sales will rise 7 percent to 15.3 million this year from 14.5 million in 2012.
"Consumers can be hard to predict, but I've been pleasantly surprised and I think the industry has that the car sales have been rebounding…. People are buying automobiles today," General Motors' CEO Daniel Akerson told CNBC earlier this month.
Despite improving U.S. industry sales trends, the Detroit automakers' stocks have been market laggards. Investors are worried about Europe and the group's underfunded pensions.
Ford shares are little changed year-to-date and GM has lost 3.5 percent, while the S&P 500 is up nearly 11 percent. Meanwhile, Japanese automakers have outperformed their U.S. counterparts with Toyota Motor up 8.5 percent.
Morningstar's Whiston said, "Both companies [Ford and GM] are going to have another horrible 2013 in Europe and there is great uncertainty as to when this gets better for everyone not named VW, BMW or Mercedes."
The European auto association, ACEA, reported a 10 percent decline in February new vehicle registrations from a year earlier. The U.S. automakers fared far worse, with Ford experiencing a 20.8 percent drop, and GM seeing a 20.1 percent decline.
(Read More: Europe's Auto Market Shrinks Further in February)
But Sterne Agee's Ward said both car makers have restructured their European operations, which should mitigate any losses.
"Europe is a situation where both companies are going to lose between $1.5 billion to $2 billion," Ward said. "Both companies are going to make $8 billion to $10 billion in North America. So the North America market is the real profit driver."
Whiston, however, said there's some uncertainty about whether these plans will absorb Europe market weakness. "I think investors aren't sure if it's enough and would prefer to wait out the recovery before getting in," he said.
Underfunded pensions are also keeping investors from jumping back into auto stocks, Whiston notes.
Wall Street Auto Bulls
While investors have so far been reluctant to race into Detroit automakers, Wall Street analysts remain bullish. According to Thomson Reuters, the median Street price target on GM is $35, implying about 25 percent upside from current levels. The median price target on Ford is $15, implying 15 percent upside.
Ward has "buy" recommendations on both U.S. auto stocks but prefers Ford.
"Ford is a better company," he said. "They're two to three years ahead of GM in their restructuring from the cost standpoint and product and balance sheet restructuring."
Whiston is also optimistic. "I can understand investors using the pensions as a reason to pass on GM and Ford but I think that's a mistake in the long run given how good U.S. auto sales look right now," he said.
—By CNBC's Justin Menza.