The auto industry is cyclical, and right now, the market seems to agree that, as well as things are going now, problems may be on the horizon. Vehicle sales are cruising along at high levels -- which is viewed as meaning there's not much more room for growth, and suggests that the industry could be headed toward the downward swing on its profitability cycle. And that explains why its P/E ratios are so low. But maybe that pessimism is overblown.
On this industrials segment of the Industry Focus podcast, Motley Fool industrials analyst Sean O'Reilly and senior auto specialist John Rosevear talk about a few factors the market might not be accounting for.
A transcript follows the video.
This podcast was recorded on June 16, 2016.
Sean O'Reilly: Is it possible this time is different? Because as you've mentioned, Ford (NYSE:F) and GM (NYSE:GM), they have footholds in, let's take China, for example. Their middle class is the size of the United States' population. It's over 300 million people. They see our lifestyle and they're like, "Oh, we need a car." You look at these valuations, you can't buy the whole company. If I buy all of Ford and I get all my money back in six years, what is going on here?
John Rosevear: I know. Ford and GM, unlike the last time the market went south, Ford and GM have very strong balance sheets. They're in good shape. They say their breakeven point is a pace of sales around 10.5 million a year.
O'Reilly: They're doing 50% more than that, right?
Rosevear: Yeah. It's up around 16 million to 17 million, and has been for a while. That's the trough of the deep recession. Even during the economic crisis, it was only below that for a few months. But of course, their costs were much higher back then, which is why they got into trouble, but they've shaped up.
[CEO] Mary Barra and her predecessor have done a tremendous job cleaning up GM into what they call the fortress balance sheet, with a little help from the bankruptcy court, of course. Ford has done much the same with a lot of help from the huge loans that [former CEO] Alan Mulally had the foresight to take way back in 2006 when he came in.
O'Reilly: I still remember reading a case study about that. They took out those loans, they went all-in on making a great lineup of cars, and the rest is history.
Rosevear: That's it in a nutshell. I covered a lot of that at that time for the Fool, especially as they got into the economic crisis.
O'Reilly: Did you think it was a brilliant move?
Rosevear: Yes. Having met and spent some time with Alan Mulally, he is as advertised, he is really amazing. He just came in and asked the right questions. He said, "Let us do these eminently sensible things that Detroit, as a group of companies, has invented reasons not to do for decades. Let us have one product line that we sell all over the world rather than developing completely different sedans for the U.S. and Europe. Let us have one brand of cars. Let's get rid of ... We've been dabbling with Jaguar. We've been dabbling with Volvo. Let's knock that off. It's a distraction. It's a diversion. Let's sell Fords. Let's sell the same lineup of Fords all over the world, with some regional variations, but all based off the same architectures. That's key.
You can change the sheet metal and change the features and so forth, but if you have six different vehicles created on the same architecture, you can theoretically build them all on the same assembly line, given that a new auto factory is $1 billion or more.
O'Reilly: It's low-stress, for sure.
John Rosevear owns shares of Ford and General Motors. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ford. The Motley Fool recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.