Chrysler, Ford Riding Government Incentives to First Sales Gains in 2 Years

It is hard to argue with the success of the "Cash for Clunkers" automobile incentive program so far. With $1 billion already blown through, Congress is working on a $2 billion extension, despite most Republicans being against the program (probably because it was a Democratic idea, not because it is not working).

So far the average consumer is trading in their clunker for a new car that gets 9 miles per gallon more than the vehicle it replaced. The sales spike during the last week of July has led both Chrysler and Ford to report July sales gains, the first increase in 2 years for the domestic automobile industry. General Motors reported a 19% decline in sales, but still saw an enormous benefit from the program.

It remains to be seen if car sales will be sustained at higher levels, but the glass looks half full at this point. New car inventories are near all-time lows so inventory rebuilding in coming months should boost GDP pretty significantly, perhaps leading to a positive GDP print for the third quarter.

The car companies are not the only beneficiaries, however. "Cash for Clunkers" helps consumers and the country as a whole too. Higher fuel efficiency should not be understated. Consumers will save money by spending less to fill up their gas tanks, freeing up money for other things. In addition, less pollution from the new vehicles not only is safer for Americans but the environment in general as well.

Despite skepticism from many, this program does this show that smart government spending can stimulate the economy. In this case it does so in more ways than one, making the investment well worth the several billion dollars spent.

Full Disclosure: No positions in Ford or GM at the time of writing, but positions may change at any time

After 350% Gain, AutoNation Shares Look Pricey

Typically when I write about individual stocks on this blog I share bullish ideas that I am either long or thinking about going long. I was recently doing some work on AutoNation (AN), however, and since the stock looks pricey to me I figured I would share a bearish case as well.

The reason for a contrarian like me to look under the hood of AutoNation is pretty straightforward. The U.S. automobile industry is obviously struggling right now but AN has strong management and the dealers are in better shape than the car markers themselves (cost structures are more in-line without union obligations, etc). Couple that with strong buy side interest from Eddie Lampert's ESL Investments and Bill Gates affiliated Cascade Investments and my interest was peaked.

That said, it appears that I missed the boat on AutoNation, at least for now. The stock has soared 350% from under $4 per share to near $18, just below a 52-week high. The stock's P/E of around 20x is high, but part of that is due to cyclically poor earnings during the current recession.

I looked back at AutoNation's financial statements for 2006-2007 and found that earnings per share peaked at around $1.45 during the boom years. Even at that level of profitability, AN stock trades at 12 times earnings, hardly a bargain for a slow growing automobile retailer.

AutoNation has a strong share buyback program in place, which is attractive to me, and the auto retail business should slowly improve in coming years, so AN is on my radar screen. However, given the current price and the move the stock has already made (ESL and Cascade timed their buys very well), I am not a buyer here. If we got down to the low teens, perhaps I would take another look.

Full Disclosure: No position in AutoNation at the time of writing, but positions may change at any time

U.S. Energy Department Paves Way for Nuclear Power Plants, Public Companies To Benefit

You may have heard that the U.S. Department of Energy is planning to offer $18.5 billion in loan guarantees for the construction of more nuclear power plants. Not only would additional nuclear capacity reduce greenhouse gas emissions, it would also help private energy companies boost their market positions. Federal loan guarantees will reduce the cost of capital and make expanded nuclear power an easier goal to attain.

This is good news for investors too, as four publicly traded companies will share the $18.5 billion raised. The companies include NRG Energy (NRG), Scana (SCG), The Southern Company (SO), and UniStar, a joint venture between France's EDF and Constellation Energy (CEG). These utility stocks are already fairly inexpensive on a valuation basis, with high dividend yields, so new future growth opportunities will only make them even more attractive.

The growth will help some more than others (Southern, for example, is a huge power player already, so nuclear might not make a large dent in their business), but I believe ventures like these serve to identify the leaders in the energy transformation movement. As a result, investors may want to take a closer look.

Full Disclosure: Peridot Capital was long shares of Constellation Energy preferred stock at the time of writing, but positions may change at any time

Market Loves GM Bankruptcy

I kid, of course. The market is up 200 points today, not because GM is filing bankruptcy, but rather because investors seem to understand that the event itself is not at all catastrophic. After all, Chrysler is emerging from bankruptcy shortly and actually saw sales go up after they filed. It seems that most people, investors and car buyers alike, understand that Chapter 11 is a legal corporate process first and foremost and should be an afterthought to car buyers. Still, who would have thought the market would react quite so well initially?

Two short points on GM. First, the stock is up 20% today to about 90 cents. It's worthless, folks. Those who still grip their "efficient markets hypothesis" tightly can use this as a perfect case study against the theory.

Second, how will we be able to judge whether "New GM" is viable long term after they emerge from bankruptcy (which many say will be before summer ends)? It's all about cost structure. Many attribute their latest woes chiefly to the weak economy and lack of credit, but they seem to have forgotten that GM was a money loser in 2006 and 2007, when credit was flowing more freely than any other time in our history.

Consider the chart below, which shows how far from profits GM has been over the last three years:

As you can see, GM needed a near-10% mark-up over cost to breakeven on their vehicles. They never hit that goal in 2006-2007, even before they started selling cars for less than they built them for in 2008. If "New GM" can get their costs down, and have them be predictable and stay low, the company might be able to make a comeback down the road. It won't be easy, but Chapter 11 was the only way to make it even a reasonable possibility.

Full Disclosure: No position in GM, past or present.

Why Selling Your GM Stock Makes Sense, Even If Bankruptcy Is Averted

General Motors (GM) is working with bond holders to try and avert a bankruptcy filing. There are reports this morning that an agreement on a proposed debt for equity swap may have been reached. For current GM shareholders the question is pretty simple, should you sell at the current price of $1.35 per share?

Well, if GM files chapter 11 shareholders will very likely be wiped out completely (there have been a few cases when they aren't, but it's very unlikely). But what if the bond holders agree to certain terms and the company avoids bankruptcy? Isn't that possibility the sole reason GM shares trade at more than $1 right now, even though the company is effectively bankrupt?

The short answer is yes, but consider another fact. In the latest proposal made to bond holders, current GM equity holders would retain 1% of the newly restructured company's stock. In order to make the case to hold onto GM stock today, one has to argue that General Motors equity, after the restructuring, will be worth at least $80 billion (100 times the current $800 million market capitalization). How would one even begin to make that case?

Do Americans Want To Buy Fuel Efficient Cars?

There appears to be debate on this question, which is puzzling to me. I think many people are mistakenly under the assumption that "small, fuel efficient" cars equate to miniature so called "smart" cars that we see every so often on the road and in Europe, as opposed to simply something other than a gas guzzling SUV or crossover vehicle. In fact, most sedans today are very fuel efficient.

Will U.S. consumers buy these cars? Well, that question has actually already been answered. As you can see from the chart below, the top 5 best selling cars in the U.S. get more than 30 miles per gallon on the highway, and #6 on the list isn't too far behind:

Trucker YRC Applies for TARP Funds, Don't Hold Your Breath

For those who don't know, YRC Worldwide (YRCW) is the former Yellow Roadway. Here is some of what the Wall Street Journal is reporting:

"YRC Worldwide Inc., one of the nation's largest trucking companies, will seek $1 billion in federal bailout money to help relieve pension obligations, the chief executive said Thursday. Chief Executive William Zollars said the company will seek the money to help cover the cost of its estimated $2 billion pension obligation over the next four years. Under a complicated system that Mr. Zollars labeled unfair, roughly half of YRC's contributions to a multi-employer union pension fund cover the costs of retirees who never worked for the Overland Park, Kan., company."

Awfully presumptuous of him, don't you think, applying as a trucking company without any indication Treasury would ever widen TARP to include any U.S. corporation? I would be shocked if this were approved, and if somehow it is, TARP would be completely out of control.

"Mr. Zollars declined to comment on YRC's specific strategy in seeking the funds, other than to say the company shouldn't be forced to pay the pension benefits of employees who never worked for YRC."

This seems like an odd explanation. I don't know the details of the "complicated, multi-union" pension plan in question, but it strikes me as probable that if half of YRC's contribution goes to people who didn't work for YRC, then the other truckling companies are in the same boat and are paying for some of YRC's former employees. Does Zollars want to stop paying for non-YRC pensions while still having his competitors subsidize YRC's pension obligations? The whole thing is bizarre, to say the least.

Full Disclosure: No position in YRCW at the time of writing, but positions may change at any time

Why I Have No Problem With The Government Firing Rick Wagoner

Call me skeptical that since the Obama administration's auto task force ousted General Motors CEO Rick Wagoner it means the government is going to take over and ruin the auto industry. I think Wagoner's list of accomplishments (or lack thereof) shows that he deserved to be gone long ago. After all, GM stock went from $60 to $2 under his tenure as CEO.

As for whether the government should have the right to force him out, why shouldn't they have the same power that any other creditor or investor would have when trying to help a company avoid bankruptcy? Private equity invests in distressed companies all the time and as a condition of such investments always has a say in the turnaround plan, including replacing a chief executive. Having such power is the only way they feel comfortable that adequate changes will be made to somewhat protect their investment.

The government is unfortunately in the drivers seat in this case because nobody else will come to GM's aid in its current form. By doing so, however, they should have the same rights as anybody else. No more, no less. Whether they should have even tried to prevent a GM bankruptcy is another question entirely, and a very valid one at that. I have no problem with someone arguing against that, but that really has nothing to do with the Wagoner situation.

The Obama team has decided to continue the public aid that the Bush team started, probably to try and avoid further destabilizing the financial system and economy. Reasonable minds can (and are) disagree over whether that is the right thing to do or not, but Rick Wagoner had to go regardless. Don't forget, under his leadership, even when the economy was booming GM North America was in the red.

What about Wagoner's replacement, Fritz Henderson? Well, I don't think the government had a hand in choosing him. He openly and proudly announced that he was a lifelong GM'er and that Rick Wagoner was his mentor. Yikes, I guess the jury is still out on whether that is change we should believe in or not.

Full Disclosure: No position in GM at the time of writing, but positions may change at any time (I don't expect this to change in this case)

Suncor/Petro-Canada Combo Could Be First Of Many Energy Deals

Today we learned that two of Canada's largest oil producers, Suncor (SU) and Petro-Canada (PCZ), are merging in a $15.5 billion deal due to close in the third quarter. More large commodity-related deals, especially in the energy sector, could be coming. Despite the global recession, the long-term fundamentals for the commodities sector remain intact. Lower demand is clearly going to have a large effect on demand near-term (prices have already come down a lot in most cases), but unless you think the global economy will not recover, commodities will serve as an economic barometer going forward, in both directions.

When you couple temporary price declines (in the actual commodity as well as the stock prices of the large producers) with long term bullish industry trends and supply limitations (lack of credit availability limits exploration and drilling projects used to boost supply), mergers in the current environment are going to look attractive to CEOs who are anticipating the commodity markets will rebound when the economy does.

While I don't have specific companies in mind that have a better chance of being acquired than others (I would have preferred Suncor to be a seller rather than a buyer, given Peridot's long-term position in the company), but I would expect this energy deal to be just the first in a series of large deals in the next couple of years.

Full Disclosure: Peridot was long shares of Suncor at the time of writing, but positions may change at any time

General Motors Fighting Uphill Battle with Double Edged Sword

Shortly after the U.S. government lent the Big Three $17.4 billion, we learned Monday that an additional $6 billion of taxpayer money is headed to GMAC, the large General Motors finance arm. Where will this money go? Well, GMAC said Tuesday that it will immediately resume automobile financing for "a broader spectrum of U.S. customers." That is code for "we are going to lend money to people who probably should not be getting it right now."

If you think this sounds awfully strange given the current economic situation, you would be right. GMAC got into trouble in the first place by giving out loans to sub-prime borrowers for not only car loans, but mortgages as well (Ditech is owned by GMAC, for example). To stem bad loans, earlier this year GMAC increased its minimum required credit score to 700. This compared to the median credit score nationally of 723, so more than half the country qualified even after lending standards were tightened considerably.

Not surprisingly, auto sales sank after the new minimums were implemented, but I think it is unreasonable to attribute all of that decline to the new credit standards. The economy is bad, people are cutting back, and unemployment is soaring, so there are simply fewer people who can afford to buy new cars, regardless of what their credit score is.

As car inventories build and GM's losses mount, the only way to boost sales is to lend to less creditworthy borrowers. GMAC said Tuesday it will modify its credit criteria to include buyers with a credit score of 621 or higher.

This appears to be a slippery slope. Lending to borrowers with bad credit as a means to increase profits is exactly how we found ourselves in a sub-prime mortgage meltdown in the first place. With the economy worsening, this hardly seems like the time to loosen credit standards. Not only that, but doing so almost ensures that increased profits earned from higher car sales volumes will be offset by higher credit losses because GM funds the majority of its car sales through GMAC, its own financing division.

While I do not own GM stock, what is going on here should matter to all of us because taxpayer money is being used. We essentially just gave GMAC $6 billion which it is using to lend to borrowers with credit scores as much as 100 points lower than the national average. Such a plan can't possibly increase the odds that the government gets its money back on these emergency loans. Since Uncle Sam will be first in line to collect its money, GM shareholders are likely to be left with very little unless the company sincerely changes its ways. As this week's news is more of the same, I have no interest in going near GM stock.

Full Disclosure: No position in General Motors at the time of writing, but positions may change at any time

Update (12/31): Barry Ritholtz points out that GMAC doesn't even know what a sub-prime borrower is.