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:
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:
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.):
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
What’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