U.S. auto sales were up big in 2014 and are expected to stay strong in 2015:
Oil prices have collapsed and are expected to stay low, fueling demand for pickup trucks, SUVs and RVs...
The average age of the U.S. auto fleet is at a record high 11.4 years while the average age of a full-size pickup truck is an even older 12.5 years according to industry analysts Polk....
Auto financing is readily available...
Indeed, all the signs of a boom time for the American auto industry appear aligned, yet auto stocks are trading at depressed values compared to the rest of the stock market.
Are auto stocks ripe to buy, or are they simply an investor's value trap? Here's the real answer.
These Value Metrics Scream "Bargain"
Continuing my series on solid American companies trading at reasonable prices, it would seem that the auto sector would be an excellent place to look for value (a positive for Thor Industries, Inc. (NYSE: THO), a company I wrote about a few weeks ago).
Indeed, a quick look at the easiest valuation and yield measures available to digest suggests investors should flock into auto stocks.
GM and Ford stock trade at 9x and 9.7x estimated 2015 earnings (per Barclays), respectively, while the S&P is trading at 16x for the same period. GM pays a 3.4% dividend with a 48% payout ratio, while Ford stock pays a 3.9% dividend with a 60% payout ratio.
In a world where the 10-year Treasury yields under 2%, these are extremely attractive yields.
This has drawn the attention of some impressive investor names, all of whom have
piled into GM and Ford stock with disappointing results.
GM stock declined from $40.87 to $34.91 during 2014, a 14.6% drop, on the back of a series of embarrassing product recalls.
Meanwhile, F stock was basically unchanged on the year. Among those licking their wounds on their investments are Kyle Bass, David Tepper, Marty Whitman, Warren Buffett, Jeremy Grantham, and Joel Greenblatt.
When value investors see stocks trading at huge discounts to book value and at low P/E ratios, they can't help themselves. But maybe these stocks are cheap for a reason. Maybe they are a value trap...
This Sector-Wide Problem Looms Large
Those who are negative on the auto industry argue that an explosion in subprime auto loans, which now account for 25% of new car loans, has artificially inflated sales.
Many unworthy borrowers are accessing credit at high rates and will end up defaulting. There are signs that delinquencies could soon be a problem affecting the industry. While only 0.71% of all subprime loans were delinquent in November 2014, more than 2.6% of borrowers who took out loans in the first quarter of 2014 had missed one monthly payment by then. This was the highest level of early loan trouble since 2008 when delinquencies rose above 3% according to an analysis performed by The Wall Street Journal and Moody's Analytics.
As of the third quarter of 2014, 3.4% of all auto loan borrowers had missed at least one car loan payment compared to 3.2% a year earlier. This compares to 4.2% in 2009 at the height of the recession according to Experian Automotive
Missed loan payments could not only hurt companies like Ally Financial, Inc. (NYSE: GOM.CL) and other lenders, but could impact GM, Ford, and other automakers if lenders begin to tighten lending standards. There are many loosely regulated finance companies that have crowded into this space that have been able to borrow cheaply in the junk bond market, and while likely not a systemic threat (the overall subprime auto market is only $900 billion in size), this area could easily become another casualty during the next recession or economic crisis.
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About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.