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Auto Stocks: Tapping the Brakes?

By Efraim Levy With auto makers offering an array of new and updated products, combined with a heavy dose of incentives such as cash-back deals and cheap financing, customers continued to flock to dealerships to purchase vehicles. The stronger-than-expected sales reported in the first quarter of 2002, along with expectations of healthy sales in the second quarter, have helped boost auto stocks this year, vs. the 20% decline the group experienced in 2001. Year-to-date through June 14, the S&P Automobile Manufacturing Index gained 8.4%, vs. an 11.2% drop in the S&P 1500 Super Composite stock index.

While the heavy price competition continues to keep vehicles affordable, it is also pressuring industry profits. And given the expectation of lower overall sales for auto makers in 2002, along with the recent strong stock performance, we at S&P think the auto-industry index is likely to remain restricted. At the same time, however, the depressed stock price of Ford (F) and the improved outlook for earnings at General Motors (GM) should temper big losses.

ESCALATING COMPETITION. To keep its sales momentum going, General Motors announced in April that it was raising cash incentives by as much as $1,000 per vehicle. GM currently offers $1,000, $2,000, or $3,000 cash back, depending on the model.

In response, Ford and DaimlerChrysler (DCX) may have to increase their marketing expenses -- or risk losing market share. Price competition exists in Europe and Asia as well.

Meanwhile, GM continues to expand globally. In April, 2002, GM and its partners agreed to buy most assets of Daewoo Motor, the Korea-based auto manufacturer that filed for bankruptcy protection in November, 2000. GM's cash investment was just $251 million for a 42.1% stake in a new company that will own the Daewoo assets. GM also limited its exposure to Daewoo's hefty debt.

DIFFERENT ROADS. What a difference a couple of years can make in the auto world. In 2000, Ford was generally considered to be the best managed of the Big Three carmakers, and it was generating more cash than it knew how to use. Chrysler was still basking in the glow of such hits as the PT Cruiser. Meanwhile, GM continued to lose market share.

Today, GM is recognized for substantial gains in quality, improved market share in light trucks, and as the domestic leader in profitability. Ford's troubles have led to a cash drain, a sharp dividend cut, and changes in top management.

Meanwhile, Chrysler is restructuring in an effort to sustain its profitability. The company was in the black in the first quarter of 2002, following six consecutive quarters of red ink.

SALES STILL HEALTHY. We at S&P project sales volume of U.S. light vehicles may decline to 16.6 million units in 2002 from 17.1 million units in 2001. This forecast reflects very modest growth in the domestic economy, a depressed stock market, and rising unemployment. Nonetheless, based on historical standards, S&P's forecast is favorable, since a sales total of more than 15 million is generally considered robust.

The Big Three U.S. auto makers should see declines greater than the industry average as foreign auto makers continue to gain market share. There is special concern that the highly profitable light truck, minivan, and sport-utility segment is facing increasing price pressure now that the Big Three's dominance is waning. Margins are projected to come down in this segment.

Increased sales of luxury import models also are hurting domestic manufacturers' margins in the luxury-vehicle category. Still, restructuring and other cost reduction efforts should offset some of the margin pressure in 2002, allowing for improved profitability levels at the Big Three.

S&P currently has a 4-STARS (accumulate) ranking for GM, a 3-STARS (hold) ranking for Ford, and 2 STARS (avoid) for DaimlerChrysler. Analyst Levy follows auto stocks for Standard & Poor's

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