It's no secret that the American auto industry is back with a vengeance. Just a few short years after the Big Three came groveling to Washington for bailout money, sales are up, the fat's been trimmed, and all three are turning a tidy profit. In the second quarter, Ford (NYSE: F) posted net income of $1 billion on over $33 billion in revenue; General Motors (NYSE: GM) turned a profit of $1.5 billion on over $37 billion in sales; and Chrysler, now owned by Fiat, recorded earnings of $436 million, following a $370 million loss last year.
But though these carmakers are firing on all cylinders once again, shareholders are still suffering. Both GM and Ford sit near 52-week lows and have rock-bottom P/Es, trading at forward valuations of 4.9 and 6, respectively. Some investors might assume that the whole industry is cheap, but that's not the case. Japanese rival Toyota (NYSE: TM) trades at a forward valuation of 13.2, and carries a market cap nearly four times that of GM or Ford, with around double the revenue of the two American automakers. Honda (NYSE: HMC) is also valued at nearly twice as much as GM and Ford, despite having lower sales. Even upstart electric-vehicle maker Tesla (Nasdaq: TSLA), having never turned a profit, has excited market-watchers enough to warrant a market cap over $3 billion and a forward P/E of 62 with big hopes for its growth despite operating in a historically low-margin industry.
Lemon or cream puff?
There seem to be a few reasons that GM and Ford look so cheap. Investors tend to have long memories, and the auto bailouts are still fresh in the minds of shareholders. These were companies that just a few years ago led themselves into a ditch through bloated pension obligations and an inability to compete with the innovation and efficiency of Japanese automakers. Who's to say this won't happen again?
Well, GM has dramatically cut its labor costs, down to $1,606 per North American vehicle produced from $3,295 in 2005, and the company has reached a breakeven point in North America based on consistent market share of 10.5 million total vehicle sales versus 15.5 million in 2007.
While Ford never borrowed money from the government, it did take on a $23.6 billion loan in 2006 as the company saw the trouble on the horizon. Through negotiating new contracts with the United Auto Workers, overhauling the company culture, and shunting brands like Mercury and Volvo, the refocused brand is now stable and profitable.
Investors likely need to see both companies overcome weakness in Europe, and in GM's case, to see the government sell its stake, but the market's mistaken if it thinks these companies are anywhere near as vulnerable as they were five years ago.
The light at the end of the tunnel
What's particularly impressive about the turnaround in American automakers is that it's come without the usual robust recovery that follows a recession. The unemployment rate has lingered above 8% for nearly four years even though the historical average is closer to 6%, GDP growth has been minimal, and our trading partners -- in particular, Europe -- have been struggling.
Demand for autos may be cyclical, but ultimately they are an inelastic good, like gasoline, which is still consumed at high levels despite tripling in price over the last 10 to 15 years. Cars are a necessity, and consumers can only avoid shelling out for a new model for so long.
The average age of an automobile in the U.S. is now 11 years, the oldest it's ever been, which means the pendulum is likely to swing away from those years of sluggish demand as more cars go beyond repair. The car companies are aware of this, of course, and are making a big bet on a recovery. New-car sales in the U.S. are expected to hit 14 million this year, up from 11 million in 2009, and analysts expect them to grow by 1 million each year for the next few years. In 2000 and 2001, that number eclipsed 17 million, so the potential for a sharp increase is clearly there, given the population increase over that period.
Carmakers are ramping up for 2015 by leasing new cars at low prices in order to keep them in stock a few years from now when demand is up again. Several foreign competitors, including Volkswagen, Honda, Kia, and Hyundai, have doubled down on future U.S. demand, building or expanding plants in the states. The number of new models produced has nearly doubled in just a few years, and all that investment could also help speed the recovery.
If these premonitions become truth, GM and Ford would appear to be two of the best-positioned in the industry with their popularity domestically, and as stocks could be coiled springs for investors with their low valuation.
Foolish bottom line
No part of this resurgence is guaranteed, of course. The U.S. economy may not make a strong recovery. Europe may still be wallowing in the doldrums, and the eurozone could even disintegrate or lose some of its weaker members. The Chinese slowdown may be worse than expected, and tensions in the Middle East could send oil prices soaring again.
But the worst-case scenario in investing in Ford and GM seems to already be upon us as both stocks sit near two-year lows and continue to absorb huge losses from Europe. On the other hand, if the automakers are at all right about 2015, both stocks could easily double if not triple from here as their high operating leverage means those extra sales could translate into huge profit growth.
Whatever the future holds, you'll want to stay informed every step of the way. That's why I recommend that Ford shareholders, or prospective investors, get a copy of our brand-new premium report that reveals whether this carmaker is "built to last." You'll get an in-depth look at the opportunities and risks the company faces as well as a year's worth of updates. Sign up now to get a step ahead of the competition, and save yourself the hassle of deciphering quarterly reports and other important developments affecting the share price. Just click right here and you can get started today.
