Is There Still Time to Ride the Auto Rebound?
The "long-awaited" housing recovery has finally become the "readily apparent" and "widely embraced" housing recovery. Yet in its rush to focus on better prospects for houses and building plots, the market has looked right past driveways and dealer lots, where evidence of a rebound in the American car economy is piling up.
As happened with single-family home construction and resales, auto production and sales plunged to generational lows when the 2008-'09 recession and financial crisis spread joblessness and cut off financing for millions of Americans. North American car and light-truck sales plunged from around 16 million per year in 2007 to a generational low near 9 million in 2009.
Of course, General Motors and Chrysler were plunged into government-managed bankruptcy protection and numerous parts suppliers followed. Since then, the industry leaders have slimmed down, cut unproductive capacity and strengthened their balance sheets, making them solidly profitable at lower levels of industry sales.
Sales have been steadily improving, first with 2009's "cash for clunkers" government trade-in incentives and since then on their own. North American volume is on pace to hit 14.5 million this year and should continue climbing back toward that 16 million pre-crisis threshold.
As is the case with housing, the depressed activity during and after the recession should mean several years of rising sales and production to meet pent-up demand. Unlike housing, though, where construction levels and prices reached bubble proportions unlikely to be seen again any time soon, auto sales before the crisis were right in line with their long-term trend and well-underpinned by employment and broad economic conditions.
The average age of a car registered in the country is at a record high at almost 11 years, and the average full-size pickup truck is more than 12 years old and one out of eight pickups has been running the roads more than 20 years, which will support replacement sales for years to come.
Investors have excitedly rushed to bet on the housing market's return to life, bidding up the stocks in the PHLX Housing Sector index by more than 60 percent in the past 12 months. Bellwethers Home Depot, D.R. Horton and Sherwin-Williams have appreciated by a similar magnitude.
Auto stocks, on the other hand, have gone virtually nowhere over the past year. Ford Motor, which never directly received a government bailout and is probably the best-managed of the Detroit majors, has seen its shares flat-line between $10 and $11 since late 2011. Johnson Controls, a venerable old industrial company and a leader in car-battery and auto interiors, is trading not far above its 52-week low in the mid-20s, in part due to weakness in its large European market.
As result, these stocks are out-of-favor and cheap based on the companies' current profit levels and the likelihood that they will continue to benefit from the multi-year tailwind behind global auto sales.
Ford, which earned $6.5 billion in pretax profit the first nine months of the year - more than in all of 2011 - is on pace to post $1.30 a share in earnings this year. With its shares currently trading at $10.67, this leaves the stock just above 8-times earnings, quite attractive given that these are not yet peak-cycle earnings.
Ford's president for the Americas, Mark Fields, who will become chief operating officer Dec. 1, this week told investors its profit margins in North American would be pinched due to customers' shift to smaller vehicles and an uptick in competition in terms of rebates to buyers.
Still, Ford's margins here are the envy of the industry, and the company and stock have already absorbed a steep profit decline in Latin America and reduced sales forecasts in recessionary Europe. The company's ongoing production revamp to standardize vehicle platforms globally should pay efficiency dividends in coming years, too.
Johnson Controls, which in addition to batteries and car interiors runs mechanical systems in commercial buildings, dates to the 19th century and has paid a cash dividend on its shares continuously since 1887.
The company enjoys a 30% market share for auto batteries in China, the world's largest car market, and is far along in developing "start-stop" batteries for a new class of energy-efficient vehicles that turn off when not in motion.
The stock, around $25, has a 2.9 percent dividend yield and fetches less than 10-times Wall Street's consensus projection for 2012 earnings of $2.60 a share and about 8-times the 2013 forecast. Management takes a long-term approach to developing its business and is shareholder-focused.
Of course, the drag of consumer stress in Europe and the prospect of a wavering U.S. economic recovery due to possible government spending cuts and tax increases could thwart these stocks' progress in the near term.
But given the way the auto sector is shaping up as one of the two main engines of the U.S. economy over the next couple of years, they should reward investors who can look past these challenges.
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