Ford or GM: Which Stock is the Better Bargain?

David Sterman's picture

Friday, August 5, 2011 - 11:00am

by David Sterman

As the calendar flipped from 2010 to 2011, stock strategists routinely included both Ford (NYSE: F) and GM (NYSE: GM) among their top picks for the coming year. After all, both car makers had staged a remarkably recovery and looked poised to boost sales and profits at a continued robust pace. Seven months later, the wheels have fallen off, and each stock trades near a 52-week low.

Judging by the stock price movements for both of these companies, you would think consumers are about to stop buying cars and trucks, as was the case in 2008. Will this really be the case? After all, the economy was imploding in 2008. Now, it's merely flat. Another question: if investors are being overly bearish about these automakers, then which one has the better looking stock right now?

First, let's take a quick look at how business is faring so far this year. Thee figures in the table below compare the first six months of 2011 with the first six months of 2010.

One item quickly jumps out. Even though Ford and GM have both posted similar sales gains in the first six months of 2011, their profit pictures are very different. Ford's profit growth lags sales growth, while GM's profits are soaring. The difference lies in 2010, when GM was incurring massive restructuring costs ahead of its subsequent public offering. Back out those costs, and GM would like a lot more like Ford, which means profits would be growing a bit more slowly than sales. You can blame it on a near-term spike in costs for everything from steel to research and development (R&D). Both companies are spending heavily on engineering right now to develop the next generation of cars and trucks slated for release in the next 36 months. In GM's case, it's simply a matter of catching up. The company cut R&D investments sharply when the economic crisis hit in 2008 and 2009. In Ford's case, it's about staying ahead of the curve as rivals try to catch up.

You should note one other item from the table above. Ford generates roughly $8 in operating profit for every $100 in sales, while that figure is just $5 for GM. Ford has managed to become one of the leanest, most highly profitable automakers in the world, largely by focusing on fewer platforms and powertrains and then deriving many varied models off of them. For example, you can get a Ford Taurus, a Ford Explorer, a Ford Edge or a Ford F-150 all with Ford's new 3.5 liter "eco-boost" V6. It's not a cheap engine to manufacture, but Ford is "making it up on volume," as they say. GM, which has had a string of management changes, has yet to establish the rigorous foundational framework that eventually leads to best-of-breed production strategies. This means GM's profit margins will likely lag those of Ford for some time to come.

Yet both stocks are awfully cheap. Each stock trades for just six times projected 2011 profits. This dowdy multiple is largely due to concerns that profits can't rise any higher from here as consumers remain in a funk and operating costs rise. On the first count, it's hard to precisely forecast demand for new cars and trucks. If the economy falls back into recession, then industry sales are likely to stay at current depressed levels. Then again, so many consumers failed to trade up when the last economic crisis hit, so the average age of a typical car on the road (which is currently more than 10 years) continues to hit new records for the modern era.

Yes, it's a new axiom that today's cars last longer. But past 150,000 miles, repair costs still rise quickly. Moreover, many new vehicles are far more fuel-efficient than their predecessors, and as long as gasoline remains above $3 a gallon, a move to a newer vehicle makes ample financial sense for the 85% of Americans that are still employed.

Assuming the economy doesn't fall off a cliff in coming quarters, many still expect industry sales to steadily rebound, as they are still 40% below levels seen in the middle of the last decade. This explains why both Ford and GM are expected to boost sales 10% in 2012.

What does this mean for the bottom line? Well, analysts think Ford's profit growth will remain stalled in 2012 at around $2 a share, while they predict GM can boost profits 20% simply due to remaining benefits from a recent streamlining (whereas Ford has already picked the low-hanging fruit).

Yet the simple fact we're talking about Ford earning a steady $2 a share and GM earning close to $5 a share in 2012 should be the key takeaway here. These companies are dealing with a lousy global economy, yet are still extremely profitable, with each automaker on track to post its highest operating margins in nearly a decade in fiscal 2011. Looking ahead to 2013 or 2014 when the global economy is getting healthier, both Ford and GM should be profit powerhouses.

Back to the earlier question. Which company is the better bargain? Since they both sport similar profit multiples based on projected 2012 earnings, we need to look at them in a different context. And on a qualitative basis, we're really talking about two vastly different companies. Ford has steadily proven itself to be one of the best run industrial firms in the United States and perhaps the world. Management seems to repeatedly build on smart move after smart move. GM, on the other hand, seems to be groping for a viable long-term plan and inspires less confidence for the road ahead. To be sure, GM's recent quarterly results have been quite good -- much better than the flagging stock price might indicate. But until the automaker establishes a consistent management team -- led by "car guys" and not financial engineers, the risk remains that its product lineup will never become a big hit with consumers.

Admittedly, the surging Japanese yen makes it that much harder for Japanese automakers to dominate as much as they have in the past, but the Korean automakers appear to have filled any void the Japanese have left.

Action to Take --> Were it not for Ford, I'd be a huge fan of GM. It's a far healthier company than it was a few years ago, and its now-pristine balance sheet, which has ample cash ($34 billion) and little debt ($5 billion), is a thing of beauty. (Ford now has a net cash position of $8 billion. This figure should rise to $20 billion by the end of 2013, according to analysts.)

Yet when picking stocks, you need to go with the best operators. This means Ford, which is doing admirably right now, looks poised to do extremely well down the road. Shares are trading near a 52-week low, off more than 40% since peaking in late January, look screamingly cheap.

P.S. -- I don't know if you're aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America's electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.