Many investors are hesitant to own such automotive stocks as General Motors (NYSE: GM ) , Ford (NYSE: F ) , or Chrysler when they file for IPOs because they are in a brutally cyclical industry. It's true: When the good times roll, the auto industry is great, but when the bad times come, it can get ugly and profits can disappear in the blink of an eye. Right now, things are good and getting better day by day. That led to Detroit's two biggest automakers posting strong third-quarter results. Here are some highlights and key factors for why their surge may be far from over.
Ford was the first Detroit automaker up to bat and it swung for the fences during its 17th consecutive quarter of profitability. Ford topped Wall Street estimates as revenue jumped 12% to $36 billion while its pre-tax profit of $2.6 billion, a $426 million improvement from last year, set a company third-quarter record.
Ford also set a record third-quarter automotive operating related cash flow of $1.6 billion; if you're keeping track, that's a lofty $1 billion improvement from a year ago. Ford also improved its pre-tax profit through the first three quarters of 2013 by $1 billion, reaching $7.3 billion. To top everything off, Ford had year-over-year market share gains in every region in which it operates.
Narrowed losses in Europe represented a big development for Ford, as they were (as you'll see later) for crosstown rival General Motors. Ford managed to slim down losses on the continent to $228 million in the third quarter; that's a $240 million improvement over the same period last year and $120 million better than the previous quarter. Its improvement there was due to production capacity cuts of 18%, which could save as much as $500 million annually.
General Motors was second up to bat during its 15th consecutive quarter of profitability. It reported a strong third quarter, although its revenue increase of 4% lagged Ford. General Motors' adjusted pre-tax earnings totaled $2.6 billion, or $0.96 per share, which was good enough to top Wall Street estimates of $0.93 per share.
General Motors saw slight increases in global deliveries, global market share, and adjusted automotive cash flow as its turnaround continues to gain momentum. One of the most significant improvements was found in its North America margins, which checked in at 9.3%. The company is well on the way toward achieving its goal of reaching consistent 10% margins by mid-decade, although it will do so several years behind rival Ford.
General Motors has also seen significant improvement in Europe. Its combined losses for the first three quarters of 2013 are down nearly to the same level as just its third-quarter loss last year.
Ford and GM's aim to break even in Europe or, dare I say, turn a profit by mid-decade, would be a fast way to juice earnings per share in the coming years, something that will surely be reflected positively in their respective stock prices.
Another major highlight for General Motors was the selection of its Chevrolet Impala as the highest-scoring sedan in Consumer Reports' ratings -- the first time an American car has accomplished the feat. Its Chevrolet Silverado was also named "Best Truck" by Consumer Reports, but that may be short-lived after Ford's next-generation F-150 hits the market in 2014
Furthermore, General Motors' was able to refinance $4.5 billion in high-cost obligations, which will go a long way toward strengthening its balance sheet. Moody's was the first credit rating agency to upgrade General Motors to investment grade, but the others are likely to follow as Detroit's largest automaker continues to improve its balance sheet and become more profitable. It has a lot of work to do if it wants to fix its damaged brand image, but having the Treasury Department exit its position soon and GM's fresher vehicle lineup will be a good place to start.
So the good times in the auto industry are here, but are they about done? I don't think so, and here's why.
Why vehicle demand will stay strong
Some investors are getting anxious that as seasonally adjusted annual rates, or SAAR, of vehicle sales creep toward pre-recession levels that we may be approaching the peak of vehicle demand -- but I think that's incorrect.
There's still plenty of pent-up demand remaining as the average age of vehicles remains at a record-high 11.4 years. If North America continues to have years of high SAAR of vehicle sales, and the average age of vehicles on the road begins to decline rapidly, then investors should be wary of demand weakening in the following years. That just isn't the case right now.
Also, people tend to forget that eventually vehicles age past their usefulness and are scrapped entirely. This tends to happen much more often as cars reach 13 years of age; because the average car is nearing that age now it will soon be scrapped more often and spur more new- and used-vehicle demand. Moreover, while we are nearing pre-recession SAAR levels, we have to account for several million additional households created while vehicle sales were very weak, which leaves auto sales per household below historic norms. For those reasons, I believe that the automotive industry's rebound has much more left in it, and more strong quarterly and annual earnings reports should follow this third quarter.
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