Bull Vs. Bear: The Future Is Looking Up For Major Automakers

By Will Ashworth | July 09, 2012 AAA
Question: Are automakers a smart investment right now?

Bull's Response

Care to guess how car stocks are performing? All you have to do is look at the performance of the First Trust NASDAQ Global Auto Index (Nasdaq:CARZ) or the Global X Auto ETF (ARCA:VROM) over the past year. As of July 5, both are down more than 20% compared to 4.5% for the S&P 500. Doing better in 2012, up more than 7%, both are still trailing the index. Is there any hope for the major automakers at this point or is it dead money indefinitely? I see several reasons for optimism. Here's why.

Pent-Up Demand

The average age of American cars on the road is 11 years old, an all-time high. Compare that with the United Kingdom and Canada where the average age is 7.4 and 8.6 years, respectively. Now think about the unemployment rate in the United States. It's currently 8.2%, the same as in the U.K. and 100 basis points higher than Canada's. The average age of cars in the U.S. is almost four years greater than across the pond, yet the unemployment rate is exactly the same. However, the American gross domestic product (GDP) per capita in 2011 was $48,387 compared to $36,090 in the U.K. Then, consider the per capita net worth in the U.S., in the first quarter of 2012, which was above $200,000 for the first time since 2008. American businesses and individuals have been scared in large part by the media into doing nothing but standing still, afraid to step off the curve. Eventually, Americans will start replacing their vehicles when they realize they're not going to fall into the sea.

Car Sales Holding Firm

June sales in the U.S. hit 14.01 million cars sold on an annualized basis against a forecast of 13.9 million - the highest in five years. General Motors' (NYSE:GM) sales jumped 16% year over year, Ford (NYSE:F) jumped 7% and Chrysler jumped 20%. Business is looking so solid that estimates for 2012 are holding firm at 14.5 million cars being sold. Most importantly, car dealers are getting better money for every car they move off their lots. The average sale in the month of June was $30,508, 2.9% higher than June 2011. Yes, Virginia, there is a U.S. automotive recovery.

Emerging Markets

At this point, the weak spot in the auto world is Europe. Although the U.S. looks like it will provide growth in the next 12 to 24 months, emerging markets should continue to provide the real push in sales. Even though China is imposing quotas in its biggest cities to limit the number of cars on the road, it should still be able to generate significant growth (2012 estimate of 10%), especially if the government resumes subsidies for people in rural areas who trade in their old vehicles.

India's growth had been going great until July 2010 when the government deregulated gasoline prices, but not diesel. Since then, gas prices have risen 64% creating a tremendous gap between the two types of fuel. The million-dollar question is what the Indian government will do next. If the government decides to tax the sale of diesel vehicles to level the playing field, it might end up severely damaging the Indian auto market. The sensible thing is to deregulate diesel prices as well. It will be an unpopular move, but it will be the right one. I see it happening, which will lead to stable if not spectacular growth for many years.

Brazil experienced double-digit sales growth from 2004 through 2011. Like the other emerging markets, 2012 appears to be a year of slower sales. Brazil's economy came to a screeching halt prompting banks to reduce the number of car loans it's willing to make. The Brazilian government responded by reducing its bank deposit requirements so financial institutions would relax their underwriting standards slightly. The move appears to have worked. Sales in June grew 23% to 353,200 vehicles.

Despite each country's problems, the upside outweighs the downside.

Green is Good

The problem with environmentally friendly automobiles is that the selection available isn't nearly as broad as those for plain old gas engines. With the consumer, it's become a chicken or egg thing. Consumers will consider a Toyota (NYSE:TM) Prius or a Honda (NYSE:HMC) Insight but not until the selection is better and the price is lower. The Obama government has proposed fuel economy standards for light-duty vehicles by 2025 that will achieve a minimum of 54.5 miles per gallon while emitting no more than 163 grams of carbon dioxide per mile. Estimates suggest this standard will save consumers $61 billion in gas annually or $4,000 over the life of an average vehicle.

Oil company CEOs would surely dispute these figures but no one in their right mind should be opposed to achieving these numbers. To get from where we are in 2012 to where the U.S. government wants us to be by 2025, a great deal of innovation is necessary to make this happen. Innovation means jobs and a better America. Whatever technology rules the day, whether it be gas, diesel, electric or a combination thereof; I don't see how the big automakers and their suppliers lose by making a more fuel efficient vehicle.

The Bottom Line

The wildcard nobody's expecting is the global economy getting stronger. Although an improving economy would increase demand for oil sending gas prices higher; ultimately a more confident and employed America would move quickly to replace their old clunkers. In 1995, the average age of a car on the road was 8.4 years, exactly where Canada is today. I can't see this gap continuing forever. While cars are lasting longer these days, which contributes to the average age rising over the past 17 years, it's hard to imagine Americans sitting on their cash indefinitely. Like investing, I expect U.S. car sales to revert to the mean, somewhere in the vicinity of 16 million vehicles annually. Having figured out how to make money on 12 million vehicles, now is a great time to invest in the major automakers.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

Don't forget to read the Bear Side of this debate and weigh in with your opinion below.

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