1/14/2008

General Motors or Toyota: Which will speed ahead?
By David Silver

The auto manufacturing industry has come under pressure in recent months due to a plethora of economic headwinds in the United States, all which heighten the potential downside risk to earnings in 2008.  The following bullet points help to illustrate why the auto industry will continue to struggle (at least in the U.S.) as the New Year progresses.

• Weakening consumer confidence
• Slowing consumer spending
• Higher fuel prices

Weakening Consumer Confidence
Consumer confidence has trended lower since the summer fallout in the credit and sub-prime mortgage markets. When taking into account recent economic data points, including the struggling job market as well as higher input prices, it’s reasonable to assume that consumer confidence will remain on its downward trajectory in coming months.

Slowing Consumer Spending
The United States’ growth engine is consumer spending driven, accounting for approximately 70% of GDP.  Despite the 1.1% increase in November (which can be dismissed as seasonality), personal spending has been trending lower.  Over the past week, monthly sales for the retailers has been pouring in and save for a couple of names, such as Wal Mart, Costco, Urban Outfitters, and Aeropastle, the results were extremely disappointing.  Amazon announced this was the best holiday selling season it has ever experienced, but the fact remains that consumers held back in their holiday gift giving purchases.

Higher Fuel Prices
Our next reason for being cautious, higher fuel prices, will continue to put a dent into people’s disposable income and force a cutback on the large ticket durable goods, such as automobiles.

In the week-ended December 31, 2007, the average price for a gallon of gasoline was 30.8% higher year over year, crossing the $3.00 barrier yet again.  With crude oil prices surpassing the $100 mark on January 2, 2008, gasoline prices are only expected to continue to move higher heading into peak spring/summer demand.  Oil has pulled back slightly as the strength of the U.S. economy has caused demand expectations to diminish (slightly).

Where is the breaking point for the American consumer?  At what point do people modify their driving habits, but continue to spend? When do people stop driving all together, is there even such a point?  No one really knows the answers to those questions.  We find ourselves asking ourselves the same questions; $3.00 used to be considered the breaking point, but that clearly has not been the case.  While higher fuel prices have helped boost the sale of hybrid vehicles, it has come at the expense of sales of the industry’s higher margin SUV and light trucks.

December Auto Sales
General Motors was able to hold off Toyota as the largest auto manufacturer in the United States for another year in terms of sales.  The same couldn’t be said for Ford, which lost its title as the second largest auto manufacturer to Toyota.  Ford had held that title for the last 76 years, dating all the way back to 1931.

For the month of September, GM sold a total of 319,837 light vehicles, down 4.4% year over year from 334,501 in December 2006.  Despite the decline, there were some positives. Comparisons below are year over year.

• Cadillac still posted a sales gain for the month, as higher income households continued to spend for big ticket items.
• Sales of the Chevy Cobalt increased 29.3% to 17,951 from 12,691.
• Sales of the Chevy Malibu increased 6.7% to 12,172, and continued to cut into Toyota Camry’s lead, with its sales declining 1.8% during the month. 
• Despite total GM truck sales falling 0.8%, sales for the GMC Sierra rose 12.8%.

For the month of December, Ford sold 211,194 vehicles, down 8.9% from 231,900 in December of 2006.  We were hard pressed to really find any true positives out of the release. 

• The December sales drop included 13% and 1.0% respective declines in retail and fleet sales.  If anything, the reduction fleet sales is a modest positive as retail sales have higher margins. 
• Sales of light trucks fell 10.2% to 126,014 from 140,380, as sales of the company's top-selling F-Series pickups plunging 22% to 55,069.
• Ford Expedition sales tumbled 30.2% to 7,516.
• Ford Explorer sales dropped 18.7% to 10,887.
• For the full year 2007, Ford’s sales fell 11.8% to 2.6 million from 2.9 million the year before.  Adjusted for one additional selling day in 2007 compared with 2006, Ford’s sales fell 12.1%.
• The only true positive for the month was the growth of the Edge hybrid SUV, in which sales surged more than 500% to 13,722.

For the month of December, Toyota sold 224,339 vehicles, down 1.7% from 228,322 in December of 2006 and compared to 211,194 from Ford and 319,837 from General Motors.

• Total passenger cars fell 1.7% to 121,581 from 123,630 and surpassed General Motors tally of 116,583.
• Sales of the Corolla and Camry fell 2.7% and 1.8% respectively, as the Chevy Cobalt, Chevy Malibu, and Ford Fusion continue to make slight in roads in taking market share. 
• Sales of the Prius increased 53.0% to 14,212.
  Sales of light trucks dropped 1.8% to 102,818 from 104,692, primarily as a result of the steep drop in SUV sales.
• The biggest highlight came from the pick-up truck segment, which saw sales jump 14.8% to 32,508, despite the high cost of fuel, due to a 54.1% jump in Tundra sales, which more than offset the 16.2% drop in Tacoma sales.
• For the full year, Toyota sold 2.62 million vehicles up 3.1% from 2.54 million, slightly ahead of Ford’s 2.57 million.  Adjusted for the one additional selling day, sales increased 2.7%.
  

What To Look For In 2008

So now that we know the issues plaguing the auto sector, how does an investor go about investing in an industry that will continue to garner considerable negative news flow in 2008?  It is important to look at overseas sales growth trends from the basket of companies in the group.  During the third quarter of last year, General Motors had 58% of its sales generated from outside of North America, with CEO Rick Wagoner expecting this figure to increase to 75% over the next decade.  Toyota, on the other hand, has approximately 63.0% of its sales coming from North America.  China, Russia, India, and Eastern Europe, as well as Latin America are the most important emerging economies for the auto markets, with a good deal of emphasis being put on high growth nations such as China, India, and Russia.

The companies that can win in the market share battle in the aforementioned emerging economies, while controlling operating expenditures, will emerge as the true winners from this challenging environment.  We believe that GM will be able to hold onto its title as the world’s largest automaker for at least one more year as a result of its explosive growth overseas during 2007 being maintained.  Toyota surpassed Ford as the second largest automaker in the U.S. and worldwide during 2007, a position our work suggests will be maintained.

The United Auto Workers (UAW) union strike in 2007 has given Detroit’s Big Three automakers more of a fighting chance to compete with lower cost Asian OEM’s, but those financial benefits are still years down the road.  It will take time to turnover the workforces, getting rid of the higher paid hourly workers for the younger two-tiered payment structure that was agreed upon.  We do think the employee efforts will make the Big Three more competitive, but investors are reminded that these panaceas are not a miracle drug, but more along the line of physical rehabilitation.  Our favorite investment recommendation in the industry is General Motors, and with hard work, there is a light at the end of the tunnel.  Note: For those of you wondering, no, it is not a train.