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Drive Safely

Elliott Gue
Elliott Gue
Who are the surprise winners and losers in today's market reality? Click here to find out!

High gasoline prices, debt downgrades and enormous legacy costs weigh heavily on the US Big Three automakers. Despite the bad news, the auto industry offers tremendous opportunities.

General Motor's Hummer isn't selling like it used to. The Hummer H2 has been among GM's most profitable model lines since its 2002 introduction, but sales of the H2 slipped 52 percent this October against the year-ago period.

And Ford fared little better with its lineup of SUVs and trucks--sales slipped more than 50 percent in October.

Clearly, higher gasoline prices are starting to pinch sales of vehicles that can't deliver fuel efficiency. But this is only the latest in a litany of bad news to hit Detroit in the past year. Last spring, the major ratings agencies cut General Motors and Ford debt to junk, significantly raising their cost of borrowing money.

And companies like GM and Ford have huge unfunded pension plans. It's become increasingly difficult to meet those obligations. Combined unfunded pension liabilities of GM and Ford total more than $20 billion, more than five times their combined 2004 earnings.

Fortunately, Detroit's headaches offer some outstanding opportunities. While SUV sales have slumped, sales of smaller cars and ultra-efficient hybrids have soared. And although GM's stock has been crushed for a good reason, there's value in GM bonds.

Detroit's Deals

GM's common stock is a risky proposition. The company has juiced up its sales during the past few years by offering huge incentives and discounts. This discounting has hit its revenues. Without improving profitability, there's little catalyst for a rally in GM stock.

Like the common stock, GM bonds have been hit, too. The selling became extreme last spring when S&P cut GM debt to junk.

Despite the selling in GM bonds, the risk of bankruptcy and default on the bonds remains low in the short run. General Motors Acceptance Corporation (GMAC), the company's financing arm, offers products as varied as car loans, mortgages and deposit accounts; GM has already announced that it's considering the sale of a majority stake in GMAC. Private estimates peg the value of that stake at more than $15 billion—enough to temporarily ease the company's financial troubles.

And the recent bankruptcy of Delphi, a major supplier to GM, could also act as a catalyst. Prior to the bankruptcy, Delphi's workers were paid some of the most generous salaries in the industry. The Chapter 11 filing has forced those unions to agree to some major wage and benefit cutbacks. This should make GM's own workforce more willing to negotiate cost-saving concessions.

What's more, in the near term, falling gasoline prices will help stabilize SUV sales. Gasoline prices spiked sharply in September and early October; the national average gasoline price is now $1 off those post-hurricane highs.

Our favorite play on GM is Advantage Portfolio holding GM 6 3/8 Percent Bonds of 05/08 (CUSIP: 370442AY1) currently yielding more than 12.9 percent. These bonds mature in roughly two-and-a-half years—the risk of a GM default is minimal during this time frame. But if the company were to file for bankruptcy, the bondholders are among the first in line to get paid. The GM 6 3/8 Percent Bonds are a buy under 95.

Small Is Beautiful

While GM and Ford offered little comfort for investors this fall, Toyota Motor (NYSE: TM) reported an October sales jump of more than 5 percent. Sales rose even as industry-wide vehicle sales slumped to the lowest level since 1998.

Toyota's market share including its ever-popular luxury Lexus brand stands at 13.2 percent, just under Chrysler's 13.6 percent. It's likely Toyota will soon replace DaimlerChrysler in the US Big Three.

Better still, Toyota has been at the vanguard of the hybrid revolution; it was the first automaker to introduce a hybrid vehicle in the US market. The company's Prius hybrid remains the most popular hybrid on the market with a more than 60 percent market share. Advantage Portfolio holding Toyota is a buy under 100.

Hybrid sales in the US are growing at nearly 100 percent annually but continue to represent only about 1 percent of all cars sold in the US. You can bet that percentage is set to increase during the next few years. That spells a growing business for companies that make components for hybrid cars.

Modern cars aren't just nuts, bolts and steel but include some highly advanced electronic components. At the core, most cars have a semiconductor known as a thyristor—this chip controls the car's electric systems. As you might expect, the electrical systems on hybrid cars are far more complex than on conventional vehicles—that spells demand for more complex chips.

International Rectifier (NYSE: IRF) is one of the world's leading producers of such thyristors. The company has struggled of late to meet earnings estimates but a restructuring initiative should help. And the stock has already priced in a lot of bad news. Buy International Rectifier under 37.50.

Finally, at the heart of all hybrid cars is a battery. One of the keys to improving hybrid performance is improving battery technology.

One of the world's leading suppliers of advanced batteries is Japan's NEC Corporation (NSDQ: NIPNY). And in addition to batteries, the company has a lineup of other popular consumer electronics. Buy NEC under 5.75.

Elliott Gue will be available to take your questions until Monday, November 28. Please use the form below to submit your questions.

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