The stock market overall may be unimpressed with the record earnings reported by the Big Three automakers last month, but a number of institutional investors like what they see and are boosting their stocks holdings.
The stocks of General Motors Corp., Ford Motor Co. and Chrysler Corp. fell about two points each late last week after July sales of cars and trucks slipped below June levels because of shortages, and a Merrill Lynch & Co. analyst downgraded the rating on the stocks.
Despite the record second-quarter earnings, the stocks were trading near their 52-week lows last week and were down from the beginning of the year.
But State Street Research & Management Co., Boston, wants more of the Big Three than their proportional shares of the Standard & Poor's 500 Stock Index, said John Burbank, senior analyst, who also manages a small portfolio.
"I think the stocks have been overkilled on the downside and I am a buyer of all three,' he said.
Mr. Burbank likes General Motors, which is in a turnaround with a potential for "incremental upside surprises as a result of the change," and he is equally fond of Ford and Chrysler.
All three will have a new lineup of '95 models, giving them an opportunity to boost sales and fatten profit margins by cutting back on incentives. The recovery in Europe also should help GM and Ford because of their presence there, he said.
The $44 billion New Jersey Division of Investment, Trenton, while bullish on the outlook for Chrysler, is somewhat skeptical about GM's ability to make a comeback, leading to a somewhat underweighted position overall. The fund holds 2.5% of its $20 billion equity portfolio in the three domestic auto manufacturers, compared with their 2.8% share of the S&P 500, but has 0.9% of its equity holdings in Chrysler shares - compared with its 0.7% share of the S&P 500, said Brian Arena, auto analyst.
"Chrysler seems to have executed its turnaround, whereas GM is still trying," Mr. Arena said.
The $35 billion State of Wisconsin Investment Board, on the other hand, views General Motors as having the most upside potential. "You have a lot of improvements in their operations, and they were the worst run, so as they improve they get more leverage," said John Stiefel, auto analyst.
GM also contributed $2.5 billion to cut its pension fund liability at the end of the second quarter, toting up $4.4 billion in contributions this year. The company has said it will contribute nearly $10 billion in cash and stock over two years to pare its $22.3 billion liability for the hourly workers' pension plan.
The fund has substantial holdings in all three U.S. automakers, Mr. Stiefel said, but he declined to reveal the amounts held.
Thanks to their improved quality, styling and lower costs, the three Detroit auto producers reported record earnings for the second quarter of 1994. Just two weeks ago, GM announced it had earned $1.9 billion or $2.23 per share, up from $889 million or 92 cents per share a year earlier. Ford earned $1.7 billion, or $1.63 per share, compared with $775 million or 72 cents per share in the same quarter last year. Chrysler earlier declared net earnings of $956 million or $2.35 per share on a fully diluted basis, compared with $685 million or $1.69 per share last year.
Investors and analysts expect sales of all cars and trucks in the United States to hit between 15.5 million and 16 million next year, up from 13.9 million in 1993 and a little more than 15 million vehicles this year.
While David Bach, auto analyst for the $78 billion California Public Employees' Retirement System, Sacramento, worries higher interest rates might make it harder for consumers to finance new cars, the Valley Forge, Pa.-based Vanguard/Windsor Fund, which owned as much as 19.6 million shares of Chrysler Corp. in early 1991 and unloaded its holdings in 1992 and 1993, started loading up the company's stock again in the second quarter of this year.
"Momentum investors have moved out of the stock thinking it's too late in the cycle to own the stock," said Chuck Freeman, assistant portfolio manager. "It's not that unusual for value folks like ourselves .*.*. to move in when the momentum guys move out."
Chrysler's shares now comprise more than 1% of the mutual fund's $11.3 billion in assets. At around $47 a pop, or 25% off of its high of $63.50, Chrysler stock is "just about enough to get to our buy point," said Mr. Freeman, who also would buy Ford's shares "at a price."
Chrysler not only has gotten its act together in its product lineup but also financially. The company hopes to wipe out its $2.2 billion pension fund liability by the end of the year (Pensions & Investments, May 30) and rising interest rates should help cut its obligation further.
Moreover, the company has about $6 billion in cash on hand, and long-term debt of just about $2.8 billion, giving it ample room to make shareholders happy by hoisting its dividend or conducting a hefty stock buyback program, Mr. Freeman says.
Dan Donovan, senior analyst at IDS Financial Corp., Minneapolis, also believes the auto manufacturers are not getting the kind of respect they deserve. Because their stocks are trading at deep discounts to the market, Mr. Donovan recommends holding a larger percentage of the automakers than their portion of the S&P 500.
"The market so far continues to overlook improvements in profits," he observed, noting all three are "very attractive" at their current prices.
At projected per share earnings of $8.10 in 1994, Chrysler is currently trading at a multiple of 5.9 times, while Ford, which is expected to earn $4 per share this year, is trading at 8 times, and General Motors, expected to earn $6.25 per share this year, is trading at 8.5 times, Mr. Donovan pointed out. The S&P 500, meanwhile, is trading at 16.9 times 1994 earnings, he noted. IDS owns 1.8 million shares of Chrysler, 7 million shares of Ford and 3.5 million shares of General Motors.
So why do value investors think the market is misreading auto stocks?
For one thing, Americans who refinanced their mortgages while interest rates were still rock-bottom now have an extra $100 or $200 each month, and many are using that windfall to replace their clunkers. Besides, even if interest rates go up further, a 100 basis-point jump in interest rates will only add a few dollars more to monthly car payments, Mr. Burbank said.
"Every indication is that we are in the early stages of a cyclical recovery of the North American market," said Michael P. Ward, securities analyst at Kidder, Peabody & Co. "I would expect you will see record earnings in 1994, 1995 and 1996," for the Big Three.
For another, even if the Federal Reserve Board tightens short-term interest rates again this month to slow down the recovery at home, Europe is just beginning to snap out of its downturn. And two of the Big Three - General Motors and Ford, which have a big presence in the Continent - should be able to reap the gains of that economic revival, investors say.