Saturday, 29 April 2017

US automakers - Good value or value traps?

I was attracted by the valuation of Fiat Chrysler, Ford and GM recently noting the low multiples these stocks trade at. Compare them to the likes of Tesla and they look like a screaming buy. These are companies with extensive histories of mass producing reliable vehicles.

I think the US automakers have really upped their game since the crisis. Debt has generally been restructured, obligations to the unions adjusted etc. I had a good read of Fiat Chrysler's last 20F and was impressed by the turnaround demonstrated there.

However it was noteworthy one of the key risks for FCAU, as they disclose, is the sales of SUVs in the states. In general total sales in North America are the most profitable area of the business with 80% of EBIT and the largest area with 64% of revenues. 

FCAU 20F 2016

FCAU have some great SUVs - generally I consider American cars to be cheap and awful, I am a BMW man to the end. I remember the woeful Chrysler my parents had back in the 90s. Terrible car. But visiting Canada last year I was blown away by my rental Dodge Durango. A brilliant, nimble, massive, quality feeling SUV. Chrysler are actually making good cars! Now SUVs are by far the biggest cash cow of the company. Despite the discipline that seems to have been brought in the Fiat side this is still an automaker whose primary market is the US. They have really improved their offering. So what worries me?

US subprime auto loans are turning over. Defaults are rising - this is likely to damage sales for all automakers in the US. Also in the last 10 years the auto industry has changed significantly with more people than ever leasing vehicles and taking up finance. Cars rely on credit - and the credit cycle is turning and with it the economic cycle. It will likely happen first in the US this year and then later in Europe.

Now add to this cyclically depressed oil prices. Low oil prices mean US consumers feel more comfortable with driving 2 tonne plus heavy vehicles with at least 6 cylinders. These also happen to be the most numerous and profitable vehicles sold by the US automakers:

FCAU 20F 2016

Therefore I consider the big three automakers may be trading at low multiples of peak earnings for this cycle. [A bit like my view on UK Homebuilders Land Bankers]

Do I think these companies are structurally more sound than 2007? Yes I do. And they have better products, better workforce incentives, better debt profiles.

But faced with such a highly capitally intensive, low margin, debt financed industry that seems to be finally gaining decent profitability I fear we are rolling over. 

If I were Tesla I would be really scared. These companies can actually produce cars -  on time and on budget - and they even make a profit on each sale.

The EV landscape is evolving rapidly and I don't expect the majors to lie down and have Tesla steal the show. Established automakers have had the origins of self driving technology since the early Mercesdes S Class models 20 years ago. I would rather own any of these three established US automakers than Tesla. 

But who can stand in the way of one man (Mr Musk) and his multifarious dreams? i.e who is brave enough to short it given the rampant price momentum...

My conclusion on US automakers is that short term they are value traps - when the cycle turns I think they have great potential for a risky leveraged bet on consumption. They are not yet discounting a slowdown in sales and credit so I think this is not the time.

Disclaimer: I have no interest at present in any of the stocks mentioned in this article. This article contains opinions not investment advice. If in doubt read my disclaimer.

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