Ford (F, Financial) and General Motors (GM, Financial), two of the world’s largest automakers, have been battered since the beginning of the second half of last year. Ford has been trading in a tight range of $12-$14 since 2013, while GM has been trapped between $26 and $36. Though things have improved operationally for both these automakers since the recession, the prospect of things slowing down in the U.S. has taken a huge toll on their valuation, and there seems to be no light at the end of the tunnel.
The biggest problem both these companies face is that their operating performance is tied to their performance in one single region, North America. Though both these companies sell their cars globally, outside of North America they hardly make any profits. Europe has been an Achilles heel for Ford. However, the company seems to have turned a corner this year, finally reporting operating profits after running into losses for many years. But even then, the European market is many years away from showing a meaningful contribution to overall operating income.
GM and Ford by the Numbers
GM Europe brought in nearly $5.4 billion in sales during the second quarter, compared to North American sales of more than $30 billion. The problem is, only $137 million of that filtered down to income before taxes.
As you can see, out of the $3.957 billion in income before taxes, GM’s North American operations brought in $3.647 billion, accounting for nearly 92% of that income.
Things weren't much different at Ford. Out of the $2.8 billion in pre-tax profits, the North American market brought in $2.7 billion, accounting for nearly 96% of pre-tax income. With more than a fair share of its income coming from North America, the state of the auto market there is what will decide the company’s short to medium term results, and that doesn't look rosy at all.
The Auto Segment in Perspective
The U.S. economy has been a little soft in the past few months. Deflation has taken the wind out of grocers' sails, and the housing market seems to be on stable ground but under the constant looming threat a serious labor shortage. It’s not exactly a doomsday scenario, and nobody is expecting a recession, but that does not mean that the market will stop moving up and down in the process. It has been a bit soft so far and may well remain so for the rest of the year.
Source: FRED
As for auto sales, the market has been relatively stable over the last few months even though many analysts expected it to come crashing down. This was based on the fact that the market was near the all-time peak of 18 million vehicles per month in October 2015. After growing to that peak since the great recession, the auto market in the U.S. has been moving sideways despite predictions of a sudden drop.
With credit availability not showing signs of pressure, I don’t  expect auto sales to crash and burn. However, the current sideways movement - where the market stays in a tight range of 15-17 million vehicles for the next few years, or even the next few quarters - will hit both GM and Ford equally hard, and that is extremely likely to happen considering the state of the economy in the medium term.
This is why both stocks are trading in a tight range and at extremely low valuations of around 5 times earnings. That is the way it is going to stay until we see another spike in sales or some negative indicators in the economy.
Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.
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