Driving for Profits

07/02/2004 12:00 am EST


Jamie Dlugosch

Editor, The Rational Investor

Long-term value investor Jamie Dlugosch continues to see potential in the out-of-favor auto sector. Here, the editor of the exceptional Rational Investor, offers a variety of auto-related picks including Ford Motor and DaimlerChrysler, Goodyear Tire, and Tower Automotive.

"Ford Motor Company (F NYSE) has been one of the few companies to trade higher over the last few months as traders reward the company for improved profits. The turnaround has been remarkable and the shares have moved significantly higher since first appearing in The Rational Investor last year. Analysts have had to sharpen the pencil with expectations as results have surprised to the upside. In March, analysts expected the company to earn $1.28 in 2004 and $1.53 in 2005. Those numbers now stand at $1.88 and $2.04 respectively. Earnings at $2 and a 15 multiple would put the stock at $30 per share, which remains my long-term target.

"DaimlerChrysler AG (DCX NYSE) has struggled since February and the shares have traded slightly lower, even though sales results currently outpace expectations. High oil prices and the corresponding worry over a potential slowdown in gas guzzling trucks and SUVs pressured prices. I would view the last few months as a mere pause in the firm's recovery. The company has survived the last few years of difficulty and seems to be making progress in the lagging Chrysler division. Analysts now expect DCX to generate a 2004 profit of $3.29 as the first quarter came in well below expectations. For 2005, the company is expected to earn $4.06. On a forward basis shares trade for just 11 times expected earnings. That’s not bad considering the company will grow earnings in excess of 20% if all goes according to plan. Certainly, anything can happen from here, but I’m excited about the future for DCX. Our target for DCX is $80 per share.

"The turn-around at Goodyear Tire and Rubber (GT NYSE) continues. On the surface, performance has been negative as the company eliminates deadwood, reduces costs, and restructures its business. Fortunately, 2004 appears to be the end of the line for losses. With the restructuring in place, the company is expected to post a loss of $0.30 in the current fiscal year. Analysts then expect GT to post a profit of $0.58 in 2005. That should set the stage for the company to deliver even higher profits down the road. With earnings growth, shares of GT should appreciate substantially. Over the next few years, I fully expect to see GT earn in excess of $1 per share. With such earnings the stock, at a 15 multiple, will reach my target of $15. It is not easy to stick with a company that is generating losses amidst accounting questions and difficult operating conditions. Nonetheless, the eventual recovery and reward to investors will more than offset the potential downside risk.

"Tower Automotive (TWR NYSE) is a global producer of structural components and assemblies used by auto makers. The shares have fallen precipitously over the last few months. Having lost nearly half of its value, this small-cap company has found little support in the market. As is typical with small, fairly illiquid stocks, selling can be magnified with little relevance to valuation. In the case of TWR, it would appear to be more a victim of selling pressure than a true deterioration in future business prospects. A ratings downgrade accompanying a new debt financing appears to have triggered much of the selling. As for the future, analysts now expect TWR to generate $0.22 in 2004 and $0.59 in 2005. Even with lowered expectations, TWR is incredibly cheap. The firm has a proven business model that can generate growing profits. Indeed the company has struggled, but management reacted accordingly by cutting costs and focusing on the most profitable aspects of its business. I recommend patience with TWR and maintain my target of $14."

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