4 Stock Picks to Cash in on Cars

published 13 April 2012

If the old saw "you are what you drive" is accurate, Americans have become a bunch of penny-pinching old fogies. The average car on U.S. roads is a geriatric 10.8 years old and likely overdue for a tune-up. But as the recession recedes further into the rearview mirror, Americans are likely to upgrade their cars. This spells opportunity for automakers, dealerships and manufacturers of replacement parts, as well as the people who invest in them.

There's plenty of pent-up demand for new cars, says Efraim Levy, an analyst with Standard & Poor's Capital IQ. Levy predicts that many drivers will swap their clunkers for new rides in 2012 and 2013. Appealing interest rates and loosening credit standards could help steer even more traffic to dealerships.

Booming car sales are good news for automakers, such as General Motors (symbol GM), which filed for bankruptcy protection in 2009 but has come back leaner and meaner since its stock went public again, in November 2010. Thanks to deals made during the reorganization process, the company has already streamlined many operations and has secured agreements that allowed it to close more plants and scrap four U.S. car brands, including Hummer and Saab. In September, it will freeze its U.S. defined-benefit pension plan, which ended 2011 underfunded by $13.3 billion.

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GM shares look dirt-cheap. At $24.30, the stock sells for less than 7 times the $3.67 per share that analysts, on average, expect the company to earn in 2012 (share prices and related data are as of April 12). But for cyclical companies such as GM, a low price-earnings ratio isn't necessarily a buy signal; rather, it could mean that earnings have peaked for that cycle and that profits are set to fall, if not disappear entirely. In particular, says analyst Bill Selesky, of Argus Research, investors worry about GM's flailing European division, which lost $747 million in 2011.

But Selesky is bullish on the stock, predicting that GM will become more competitive in Europe by scrapping outdated factories. Analysts at Morgan Stanley, who have an "overweight" rating on the stock, think GM's products will improve faster than investors anticipate. Morgan Stanley forecasts earnings of $4.20 per share this year, well above most analysts' expectations, and it sees the stock selling at an 18-month target priceof $45, a whopping 85% over its current price.

Ford (F) has shown signs of life as well, recently reinstating its quarterly dividend, at a rate of 5 cents per share. Ford's March sales were the highest monthly figure in five years. At $12.07, the stock trades at 8 times estimated 2012 earnings of $1.47 per share. But Ford hasn't undergone as dramatic a transformation as GM, and analysts are not quite as high on the stock. They expect to see weak sales in Europe and increased competition from Asian carmakers. Still, Standard & Poor's IQ rates the stock a buy and predicts that Ford will sell for $14 within a year.

Consider Penske Automotive Group (PAG), which sells luxury cars, financing and insurance products, repair services and replacement parts. Although Penske derives nearly two-thirds of its revenues from the U.S., Detroit's automakers account for just 4% of its sales. Luxury brands, such as Audi and Porsche, make up almost 70% of sales, expected to clock in this year at $12.7 billion. Analysts expect Penske, the nation's second-largest car retailer, to generate annual earnings growth of nearly 18% over the next three to five years. Relative to that expected growth, the stock, at $25.81 or 13 times estimated 2012 earnings of $2.01 per share, looks attractively priced. In January, the Bloomfield Hills, Mich., company boosted its quarterly dividend by 11%, to 10 cents per share, giving the stock a 1.5% yield at its current price. Brian Sponheimer, an analyst with Gabelli and Co., says Penske should be worth $33 a share next year.

Lithia Motors (LAD), which has dealerships in 11 states, may be an even more compelling buy. The Medford, Ore., company targets rural and midsize Western markets, and 80% of its showrooms don't have a competitor within 50 to 100 miles. About half of its inventory comes from Detroit. At $25.80, the stock sells for less than 12 times estimated 2012 earnings of $2.18 per share, a favorable price given that analysts predict that profits will speed forward at a 24% annual clip over the next several years.

Those old autos are unlikely to just get junked. Today's autos are older partly because they're better-built and able to hold up longer. The most obvious beneficiaries of that trend are car parts retailers, which help both individuals and professionals repair aging cars. But the stock prices of top-notch parts suppliers, such as Advance Auto Parts (AAP) and O'Reilly Auto (ORLY), have already soared. Advance, at $89.95, has quadrupled since 2008 and sells for 15 times estimated 2012 earnings of $5.94 per share, a shade above the estimated long-term earnings growth rate of 14% a year. Argus analyst Selesky recently downgraded Advance shares to "hold," predicting that high gas prices will have customers cutting back on repairs.

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