Auto stocks could be running out of gas.
The Big Three carmakers,
have jumped sharply over the past month as investors responded to some better economic data and anticipated strong sales for August. But some analysts say the rally was irrational and may soon come to an end.
"For the average investor, there's no need to go anywhere near these stocks," said Brian Lund, an analyst at Morningstar.
Even though automakers recorded some of their
best sales of the year in August, the strength came largely from incentives, such as rebates and cheap loans. Goldman Sachs analyst Gary Lapidus estimates that incentives rose over the past two months by 35% or $780 per vehicle year over year. And yet sales have not been able to match last year's levels. Ford said August sales fell by 15% while DaimlerChrysler saw sales slide 6%. General Motors said sales dipped 0.5% last month.
GM has climbed 15% over the last four weeks while Ford has jumped 10% and Daimler is up 12%.
"I think they're hitting a wall in terms of how much more they can offer," noted Bear Stearns analyst Dominic Martilotti.
Although auto firms are optimistic about spending in the second half of this year -- and have said they would reduce incentives going forward -- recent consumer confidence data have not been encouraging and the sluggish labor market continues to be a concern.
Even if the economy does improve as the year progresses, some analysts say demand for cars isn't likely to pick up appreciably. Because consumer spending never really dropped off during the economic downturn, it's not likely to increase sharply when conditions improve, they say.
"We are not expecting any significant pent-up demand that usually accompanies an economic recovery; the recovery would have to be substantial to cause 2004 light-truck sales to trend meaningfully above trend-line demand of 16.5 million units," said Credit Lyonnais analyst Charles Brady.
Although consumers have shown an incredible propensity to buy new cars even when they don't need them, Lund agreed that demand has been fully satisfied over the past few years.
Meanwhile, U.S. auto firms are losing market share to foreign companies like Toyota, Nissan and Honda, who have moved in on the American car market as U.S. firms focus on higher margin areas such as luxury cars and trucks.
Goldman's Lapidus said there is another risk to these stocks, too. He believes auto firms have understated their pension liabilities by billions of dollars because they don't account for future increases in pension benefits.
"If pensioner claims are larger than previously understood, then normal equity values should be lower than previously believed," he said. "Investors ultimately value stocks on economic reality, not accounting fiction, and because the economic reality is far different from the accounting, in our opinion, we believe that investors will ultimately care a great deal."
David Healy, an analyst at Burnham Securities, believes that while momentum in the stocks could fade going forward, he still thinks the group is undervalued. He noted that GM raised its earnings estimates in July and will probably beat consensus numbers this year. Analysts also point out that General Motors has an attractive dividend yield of almost 5%.
Still, others say the fundamental outlook is too cloudy. "We are becoming increasingly concerned regarding the pull-ahead effects of record incentives on 2003 models," Brady said, adding that ongoing labor negotiations with the United Auto Workers also could prove to be a setback.
A four-year contract covering UAW workers at GM, Ford and The Chrysler Group is set to expire at midnight Sept. 14. If a tentative agreement hasn't been reached with one of these firms by then, workers could go on strike. "Given that large news item, it's tough to say whether the rally is sustainable," Martilotti said.
Goldman Sachs and Bear Stearns have investment banking relationships with Ford, GM and DaimlerChrysler. Credit Lyonnais has a banking relationship with General Motors. Burnham and Morningstar have no banking connections with the auto companies mentioned.