Profit From These 2 Auto Stocks

by Robert Gordon

There is a sense of a swagger coming from the Ford (F) headquarters in Dearborn. And it is a well-earned swagger as the good news keeps on coming. Yet, Ford's stock price scarcely reflects what is going onf Let's take a look at this American success story and a couple of its competitors.

If ever a good decision were ever made anywhere, it was Bill Ford Jr.'s 2006 decision to fire himself as CEO of Ford and to lure then Boeing (BA) Chief Executive Alan Mulally to switch from the Everett, Washington aircraft and defense manufacturer to Dearborn. Ford has not been perfect, of course, but everything from Mulally's big bet on mortgaging the entire company was so prescient, and then followed by a highly effective redesign of the entire fleet, restructuring of the balance sheet and selling off of non-core brands. If there were a CEO of the century, Mulally would be my frontrunner for the 22nd century thus far.

The good news of recent days is twofold. Several weeks ago Fitch credit rating agency raised Ford's credit rating to investment grade. Ford had been waiting for that to be confirmed by either Moody's (MCO) or Standard and Poor's, as was required under the terms of its credit agreements before Ford debt could be regarded as true "investment grade" and that certain assets could be released from encumbrance. Moody's did exactly that on May 22, and Ford's bonds, already trading well above their par values, got a further boost. But the credit rating gave an even bigger boost to the emotional well being of Ford's management.

A look at Ford's balance sheets over the past few years shows a truly remarkable transformation. Just in 2011, Ford reduced its automotive debt by $6 billion, so that even after a bit of backsliding in the first quarter of 2012, automotive debt stood at $13.7 billion, and cash on hand stood at $23 billion. This net cash position of $9.3 billion is in stark contrast to Ford's position late in the last decade. In a broader context, Ford's first quarter of 2012 was unremarkable. Analysts are looking at 2012 earnings of about $1.50 per share this year, and $1.75 per share in 2013. The analysts have been slightly raising their projections in recent weeks, always a positive sign. The company reinstated the dividend that had been missing since 2006 early in 2012, and the yield is 1.8%.

But the real story about Ford nowadays is its product, and its customers' impressions of those products. Alan Mulally gave an interview on May 30th that Ford's big problem right now is it cannot build enough cars to satisfy prospective customers. Sales in May were up 13% from May, 2011. Oh, what a change from a few years ago. Cars like the Ford Focus, Fusion, and Explorer are in short supply, and Ford after spending years figuring out how to deal with too many factories, too many employees, and too much legacy expense is not about to invest in additional fixed cost at this time. Ford could conceivably run all its factories 24 hours per day, but because it relies so much upon its Tier One suppliers, that is impossible as they were just as scarred as Ford and General Motors (GM) were from over capacity in 2008 and 2009, driving many of those suppliers into bankruptcy.

What Ford has done, is greatly lower its breakeven point on North American sales. It used to be, Ford could only make money in North America if the market supported sales of at least 3.4 million units per year. Now, due to labor concessions, legacy concessions, and lower credit costs, that has been driven down to 1.8 million cars and trucks. But now, Ford must figure how to stem the bleeding in Europe. There, Ford has the product, and the market share. But it is dealing with is a substantial regional recession that has sapped 2.7 million cars per year out of the market between 2007 and 2011, and 2012 looks no better. The economic situation is not something Ford can fix on its own, and until European economies stabilize and recover, Ford will not make substantial profits in that area.

Ford has substantial upside if and when investors start to believe in its earnings stability and predictability enough to allow its price to earnings ratio to expand. Analysts have a one year price target of $16 per share, a price 52% above the price as I write this. Take Ford out for spin; I doubt you will regret it.

Daimler (DDAIF) is a worldwide manufacturer of primarily high end cars and trucks. In the first quarter of 2012, it sold 502,000 units, an increase of 9% from the first quarter of 2011, resulting in a profit increase of 22%, to $1.69 per share. I do not think that pace can be maintained during the balance of the year, owing to a very strong last three quarters of 2011, and a rough market, especially in Europe. However, Daimler has put together a very strong lineup of vehicles, and is also exposed to rail systems, aerospace, and related businesses, helping to smooth out cash flow and income spikes.

What catches my eye about Daimler is that analysts foresee 5 year profit growth of 15% annually, driving the 5 year PEG down to 0.50. Even in the low price to earnings world of automobile companies, that PEG is a stand out. Ford's five year PEG is 0.81, and Toyota's (TM) is 1.03. For that reason, I see Daimler as the most undervalued of the major auto companies, and believe that there is a sizable upside from the stock's current position at about $44 per share. Patient investors might also enjoy its annual, 6% dividend payment. I think Daimler offers a winning combination.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.