Auto Sales Are Up, But Does That Mean That Manufacturers Have Sound Fundamentals?

Michael Teague  |

One of Wednesday’s more significant economic data points was auto sales. The “Big 3” American auto-manufacturers, General Motors (GM) , Ford (F) and Chrysler all reported sales increases in the double-digits for the month of August for the first time in a long while.

GM had its best month since September of 2008, with total sales up nearly 15 percent on the previous year. Ford’s sales were up 12 percent from August of 2012, making for the company’s best month since 2006, while Chrysler posted its own 12 percent yearly increase, marking nearly three and a half years of consecutively rising monthly results.

There has been a consistent effort to situate the ostensibly better performance of the major US automakers squarely in the context of an economy that is working its way towards a phoenix-like revival, particularly in sectors that have the potential to create lots of jobs. But while the improvement in auto sales, particularly among domestic manufacturers in 2013, does indeed justify a good deal of optimism, perhaps even more than justified by the allegedly recovering housing market, there are certainly also no shortage of reasonable doubts.

Anyone who might be tempted to interpret better auto-sales to mean a “Detroit Renaissance” might be disappointed to learn that the actual city of Detroit is about as far away from a renaissance as it has ever been. Furthermore, while more units are being sold, it does not mean that automobile manufacturers are necessarily going to see greater profits as a result.

For instance, in June, reported that the incentives that most auto-makers have been offering these days to lure consumers into driving their products off the lot comprised some 8 percent of the market, in other words an average of $2,500 per vehicle. In other words, it could at least be suggested that some of the recovery is a matter of optics. In the case of the fire-sale-esque incentives, volume alone becomes the sole measure of the health of the industry.

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But the success of any industry also depends on the viability of the companies of which it is comprised. From the perspective of fundamentals some of the car companies, especially the big 3, do not look quite as good as their sales figures might suggest.

When screening major auto manufacturer stocks, very few meet some of the key criteria by which consumer goods companies can be judged as being in a strong position. Consumer goods companies can be considered healthy if:

-The current ratio, which measures the ability of a company working in a cyclical industry to meet obligations in the short-term (for example during traditionally slow sales periods), should ideally be greater than 1.5.

-The return-on-investment ratio that judges how much income is generated out of capital investments, should ideally be greater than 15 percent.

-The gross margin, which measures the amount of sales revenue a company can put towards other obligations after paying for the direct costs of production, should ideally be greater than 10 percent.

The following 4 major auto makers are the only ones who currently approximate those standards:

Toyota Motor Corporation (TM) – The $199.34 billion market cap company has shares currently trading at $125.84. The company has a healthy gross margin of 16.80 percent, but its ROI rate is currently at 2.9 percent, and its current ratio is 1.1. Shares have advanced 35 percent in 2013.

Honda Motor Co. Ltd. (HMC) – The $66.83 billion market cap company currently offers shares for $37.08. The company has a robust gross margin of 25.3 percent, and a current ratio of 1.3, but its ROI rate sits at 3.7 percent. Shares have advanced 0.38 percent YTD.

General Motors Company (GM) – The only of the big 3 US auto makers to ascend to this list, the $49.33 billion market cap company offers shares for $35.85. The company has gross margin of 6.6 percent, but its current ratio is 1.3, and its ROI rate is currently at 10.1 percent. Shares have risen 24.35 percent in 2013.

SORL Auto Parts Inc. (SORL) – Not even a manufacturer of automobiles, the $63.32 million market cap Chinese company makes braking systems and electronics for commercial vehicles. SORL has am ROI rate of 7.1 percent, an impressive current ratio of 4.2, and healthy gross margin of 27.60 percent. Shares are currently trading for $3.28, up 34.43 percent YTD.

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