Dear America, I Bet You Buy More Cars Soon

by JT McGee

America's car industry is ready to pop, but when?The automotive industry is particularly interesting to me. Considered to be highly-cyclical, many perceive the American automotive industry to be a speculative bet. How can people buy cars if the economy stinks?

Easy! They’ll have to.

Six Reasons We’ll Buy More Cars

Never has the revenue side of the equation looked better for the American auto industry. There are several factors in play for a revival in US car shipments:

1) Cash for Clunkers – The cash for clunkers program created plenty of car demand in 2009, but the real gains will register over the next few years. Not only did cash for clunkers take older, less efficient cars off the roads, it also removed literally tons of used car parts at the same time. Think about it; every car scrapped in 2009 had thousands of parts which could have been used to replace broken parts on other models in existence. No more!

2) American cars are old – The average age of the American auto fleet is more than 10 years old. Thanks to a poor economy, limited confidence, and fears about recession with each passing day, Americans are holding onto their cars longer than ever. Nothing better demonstrates America’s willingness to hold onto their cars than this stock chart of car parts chain Autozone:

Used car repairs look better than new car prices.

Look at that! Notice that AutoZone wasn’t really killing it until the economy sucked. Then, once recession became the new normal, they exploded! A very marginal change in attitude toward new cars meant that more cars were being repaired instead of scrapped.

3) Used car prices are bonkers – My car has GAINED value from 2009 to 2011. Everyone wants to buy a used car, and as a result, used cars are actually going up in value. Look at this chart, which compares the change in price of used cars vs. the S&P500 index and US real estate:

Used car values rise faster than S&P500

Cars are proving to be a better investment than stock funds and real estate, who would have thought! I’m not sure it makes any sense to buy a used car right now; if I had to choose, I’d buy new over used. The discount isn’t attractive enough yet.

4) American Deleveraging – Americans have slowly reduced the amount of debt they carry. Revolving balances on credit cards have plummeted, as have installment debt balances (installment debt includes real estate, student loans, car loans, etc.):

Americans pay down household debt, but for how long?

5) Japanese Earthquake – The earthquake that rattled Japan earlier this year severely crippled production by both Toyota and Honda, further affecting supply while demand stays strong relative to current production. Tack on more future supply constraints and it’s easy to see why the American automakers are poised to benefit for years to come.

6) Structural Issues – Lenders like to see that borrowers have been in the same residence and job for at least two years. A ton of people, I imagine, are getting whooped by this structural problem. With so many people losing their homes or jobs, there are a lot of people who wouldn’t meet qualifications for car loans in the present day, but who will meet and exceed them with due time.

Put Yo’ Money on the Line

Bet on a boom in American Auto SalesWhat’s the point of an industry analysis if it won’t make you money? Looking at the above points, I know that there is no better time to take control and make some moolah on the resurgence of the American auto sector.

But we have to play smart. Those greedy unions are going to want every dollar Ford and General Motors bring in. General Motors is, for me, off the table. Ford Motor (NYSE: F), on the other hand, looks downright sexy.

Some points on Ford:

Debt – There’s tons of debt on the balance sheet, but that’s what makes this a turnaround play. Debt balances are slowly being refinanced at a lower rate. Plus, the company paid down $20.2 billion in debt in the previous 12 months.

Capex low – Capital expenditures normally slaughter manufacturing companies. No worries, mate! In the past 12 months, the company brought in $11.2 billion in cash from operations and reinvested only $4.1 billion in capital expenditures.

Mike Rowe – A man’s man! Ford marketing had this guy promote their Fusion brands against Toyota’s Camry. Smooth move! Marketshare gains abound in this segment as the Fusion, Focus, and Fiesta attract people who want an economical car with good gas mileage.

China – China’s real estate bubble is about to find a needle. No worries, though. Lower Chinese growth may mean fewer car sales, but it also means lower prices for commodities like steel and copper, which are important inputs in car production. Net-net, limited long-term exposure, in my view.

Dividends – I don’t like dividends, but other people do. If Ford reinstates its dividend as expected, the stock will move higher as all the dividend fiends move in. Diggin’ it.

How I played it:

I’m in it to win it with Ford. The equity is unattractive to me, since the union contracts are still the 900 pound gorilla in the room waiting to rip someone’s head off. I’m in on the January 2013 calls at a $10 strike for an average price of $1.95. It gives me some time to think about it, and the opportunity to lock in a low entry point with more than a year of chill-time to evaluate where we go from here.

The company’s worth $20 a share in my mind, but a lot can change from here to there. Options make timing important, but they also reduce my downside. Says a lot about unions to see I’m buying options during a VERY volatile period with the VIX out of control. Then again, investors were paying $18 a share for this company earlier in the year. Sure, Europe went nuts, but never fear!

So, all things considered, I’m looking for a quick doubling or tripling of my money. If I miss, well, that means I can get the equity even cheaper. The long-term demand is there for autos, it’s just a matter of time and keeping the unions happy. Let’s ride this trend! A quick move to $14 could be 150% upside for me, whereas I’ll make 200% if the stock pops to $16 before now and January 2013. In it to win it.

Photo by: rjs1322

{ 16 comments… read them below or add one }

John Hunter October 10, 2011 at 07:40

#3 is amazing. I sold my car this summer and got 60% of the value after having driven it for 7 years. Many of these trends are good – we were buying new cars much too often (and too many). Trends like zipcars are helping reduce total cars purchased.

I do agree with you that we will be buying more new cars. The age of the fleet is a huge factor.


JT October 10, 2011 at 08:33

Dude, 60 percent after 7 years is awesome! Do you think zipcar is actually reducing car demand? I see zipcars economic advantage in reducing labor and regulatory costs from taxis. I haven’t looked very deep into their model or customer, though.


20's Finances October 10, 2011 at 10:49

The fact that the value of your car increased is crazy to me! Now, that is a new one to me. Good luck doubling your money.


cashflowmantra October 10, 2011 at 11:50

I like your investment thesis and approach. As long as a second Lehman doesn’t appear, I would suspect you will do very well.


JT McGee October 11, 2011 at 07:05

That means a lot from the option man himself. I think I’ll get at least a double, though a triple would be really nice. The position is up nearly 35% already…but you know that that’s nothing with options…in it to win!


Car Negotiation Coach October 10, 2011 at 18:52

JT- Thorough analysis, as usual. I also think the demand for cars will be going up soon. Bottom line is spending has been delayed and there is some catch up on the horizon as vehicles start to need to be replaced.

As for me personally, I’m actually considering the opposite. I’m wondering if we can become a one car family. I work from home and usually drive my wife’s car anyway….I really only need my car for emergencies. Actually, if I could only convince her that we need a motorcylce I’d be set!


JT McGee October 11, 2011 at 07:07

You know, I goofed around looking for motorcycles a few years ago. Not only were they amazing on gas, but insurance, even for a 20-something, is dirt cheap.


Hunter @ Financially Consumed October 10, 2011 at 19:10

I like your analysis JT, as a former Ford employee and shareholder I have a sentimental value for this company…not good from an investing point of view though. I last sold Ford stock when it was $1.80 per share…gulp, gasp, vomit, WTF was I thinking. I needed the money, and Mike Rowe was all about dirty jobs.

I like the auto sector for another reason. Sales may spike late this year and early next due to sustained lower energy prices…this does sway the consumer. However, if there is a massive oil spike the fleet will need to be replaced with more efficient models. More sales. That’s my simplistic take, but I like to look at the big icture first.


JT McGee October 11, 2011 at 16:03

Aw, bummer.

Honestly, if I worked for a company, I’m not sure there’s any way I could ever invest too much in it if it were publicly-traded. It’d be way too easy to correlate what I see on the backend with the daily ups and down of the market, nevermind the additional risk.


Kellen @ Accountant by Day October 10, 2011 at 20:12

If I had money in stocks (only have indirectly thru mutual funds) I would be running out to buy Ford now. I like your analysis here. Hope you’ll give us updates on how this one pans out for ya!

One of my clients bought a toyota corolla right before gas prices spiked last winter. He said it was really tough finding a used one. I’m glad I already had mine!


JT McGee October 11, 2011 at 07:25

The used car market is completely insane, especially at the $10,000 pricepoint. My girlfriend and I spent quite some time looking for a used car for her, but prices are so inflated that its not even funny.

Join in on the Ford fun! I’ll keep you up to date, and hopefully it works out just fine.


LaTisha October 10, 2011 at 21:11

I like the idea of LEAPS as a way to get in on this play. And even that far out, at a price that low, the time value erosion shouldn’t be that bad. I’ll have to take a look.


101 Centavos October 11, 2011 at 05:51

Hey JT – just to take the other side of the argument, some of macro factors you mentioned above, like lower steel prices, benefit the entire industry. Why is Ford a better bet than Fiat (Chrysler) or Daimler ?


JT McGee October 11, 2011 at 07:21

Ford makes cars people want.

Here’s why I like Ford over others:

1) Less reliant on emerging markets.

2) It’s merging its manufacturing processes together. A lot of its compact/economy/sedan lineup shares the same drivetrain/chasis. The Fusion, Focus, and Fiesta all have a lot in common.

3) Even though Ford did access some capital from the government, namely short-term loans from the Fed, everyone remembers that it wasn’t a bailout recipient, which gives it a leg up over…say, GM.

4) Ford did a MUCH better job slimming down on operations that were money losers, or which provided only the prospect of very long-term payoffs. The US automotive market needs to sell 1/3 less cars in 2011 for Ford to breakeven than it did in 2006.

5) The F-trio, as I call it, is awesome. We own a Focus, and plan to replace it only with another Focus. My girlfriend bought a Fusion, and it’s a hell of a car at the price point. I really think these three brands will create long-term, economic thinking customers who want the best bang for their buck. Consumer Reports rates all three in the best of their class. Plus, the revival of the Taurus is sure to win some hearts over once again.

6) They’ll soon be upgraded to investment grade status, which will make financing their debt load far less expensive in the future. Good timing given that we’re in a period of record low rates.

So, yeah, that’s my thinking. 😉


101 Centavos October 11, 2011 at 21:00

don’t disagree with 2 and 4. Also agree on #5, personal preference is just fine. I drive a Ford truck myself.

On #3, I don’t know it’s fair to compare to GM. That’s a pretty low standard.

Completely disagree on #1. Having a less-than-robust BRIC strategy is a weakness for Ford. Instead, Fold sold Volvo to a Chinese company.

I’m not sure that foreigners completely understand China’s real estate market. One aspect that’s almost never reported is the sheer number of apartments purchased in speculation with “grey” money.


JT McGee October 11, 2011 at 21:14

#3 doesn’t affect my view. But the “Government Motors” stigma certainly isn’t helping GM, and Ford largely avoided that.

As for #1, Volvo sold less than half a million cars per year. Besides, in turbulent markets like these, where I’m in for only 14 months at best, I don’t want any emerging market exposure. I’d just pay for it with higher beta, and ultimately higher option pricing.

It’s a value play long term. Growth in terms of global market share really doesn’t excite me as much as the future cash flow I’m already buying by owning it, pending I do decide to buy the equity itself. As far as I see it, you always get GARP if you get value. 😉

As for China, no one understands it, even if you live there. All the books are cooked, financing controls are creating problems in the capital markets, and, as you mention, there’s a lot of “grey” that never shows up anywhere. I’d prefer just ignore it, but I’m sure it’ll come into play within the next year.


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